The Miseducation of Financial Aid Leveraging

Financial aid is one of the largest investments a college or university can make to achieve its enrollment targets and support the success of its students.? While a small number of institutions have enough endowment and gift income to fully pay these investments each year, the vast majority of institutions that award institutional aid (grants and scholarships from institutional resources) do not.? Instead, these institutions turn gross income from tuition and fees into discounts, or institutional aid that is given back to students in the form of grants and scholarships.? This practice is known as financial aid optimization, or financial aid leveraging.

Let’s start with the term itself.? Leveraging implies that the institution is using its resources to leverage the behavior of students.? Influencing may be a gentler term but the idea is the same - the institution is trying to change the behavior of students to do something they may not do without financial incentives.

As discussed further in this article, leveraging has a long history of practice.? Over the years, we have become both educated that it has great potential to influence enrollment behaviors and, over this same period, have been miseducated on its role and its side effects.

Background of Practice

The history of this practice dates back into the late 1980’s and early 1990’s.? Institutions were looking for ways to attract new audiences, often from new geographic markets, following the drop in high school graduates after the Baby Boom generation.? There is always some pressure to increase the quality of students at the same time the size of the incoming cohort is staying the same or growing, so initial efforts targeted academic scholarships as the form of institutional aid preferred by enrollment managers.? It was initially practiced by private/independent institutions, as their tuition rates were higher than competing public institutions, and there was greater price sensitivity among their students and families.? Scholarships provided an additional psychological boost, creating a feel-good moment in the stressful college application cycle, and potentially differentiating the institution from its competitors (or at least sharpening the comparison between them).

Practice expanded to public institutions, following their loss of state funding in the early 2000s, as seen in Figure 1 below.? Unlike prior recessionary periods, the recessions of 2000 and 2008 left higher education with far less state funding per FTE after the economy and state coffers recovered.? The funds went to other priorities. This shift in resources placed greater reliance on tuition revenue, and discounting practices were implemented in several, then many, public four-year universities across the country.? Leveraging became a staple in the cupboard of enrollment management practice in American higher education.

Figure 1. State appropriation ratios over time (SHEEO, 2023).

An important element of early and still current practice is the focus on merit (academic) scholarships.? Before the FAFSA was available in the fall, enrollment managers had few mechanisms to signal institutional commitment to admitted students during the period when many first-time students were applying and being admitted to most institutions.? Enrollment managers used merit scholarships to signal to their fall admits that they would receive aid from the institution, thus seeking a competitive advantage and working to keep the student’s attention and focus on her college or university.? The level of financial need was unknown in the fall term (aside from a few innovative institutions that estimated need early in the process), and many institutions discovered after the fact that many scholarship students did have need, while some others did not.

As practice matured, institutional aid became more balanced.? Enrollment managers saw that need-based aid fostered greater retention, and that awarding all institutional aid into merit scholarships left too little to meet need gaps.? While there are no known formal studies on the ratio of merit and need aid within institutional budgets, it is likely that the balance still heavily tilts toward merit aid, which incentivizes initial recruitment, and away from need, which supports retention.

The Big Picture and the Big Issues

One might ask, “So what’s the problem?? Isn’t awarding aid to students a good thing?”? On the surface, of course it is.? The issue is that the aid isn’t typically coming out of a bank account but from discounting the price.? Few institutions can fully fund student aid from endowments or annual gifts, so some or much of it comes “off the top” by taking gross tuition revenues and giving them back as institutional scholarships and grants. The remaining balance is “net tuition,” which is the amount left to run the institution.

In theory, the practice redistributes resources from those who are able to pay more of the costs to help those who are able to pay them.? Another long standing criticism of the practice is that because merit aid is awarded before need is known, some students who may be able to afford more of the costs are actually receiving the discounts, forcing some of those needy students to subsidize them.? Having the FAFSA available earlier hasn’t solved this, as the critical data files needed to award aid aren’t coming in soon enough to make a difference.? In response, some savvy enrollment managers limit the amount of merit aid that is spent in the fall, reserving funds to meet need gaps, once they are known.? This “and not or” strategy is an evolved practice, and requires greater skill and more complex analyses.

Another issue is that contracts, insurance increases, deferred maintenance and other costs chew through net revenue. Unless there is significant growth each year, the institution is faced with less than adequate resources to maintain and strategically drive quality educational experiences.

The Runaway Train of Discounting

The National Association of College and University Business Officers (NACUBO) conducts an annual study of private institutions to assess their levels of discounting.? A simple formula is used, where the total amount of institutional aid awarded (from any source) is divided by gross tuition and fee revenue.? The discount rate is averaged for the study group, and trend lines can be established to understand whether there is more discounting or less discounting occurring.? As figure 2 shows below, the rate has steadily climbed for many years, and if this chart were extended another 10 to 20 years into the past, the same trendline would be seen.

Figure 2.? Discount Rates at Private Institutions, 2023 (NACUBO)

While the studies on public universities are not as long standing or frequent, a 2020 report showed that their rates had also been steadily increasing.? Figure 3 below illustrates this, and delineates the rates over time by institutional Carnegie classification groups.

Figure 3. Discount Rates at Public Institutions by Carnegie Group, 2020 (NACUBO)

In this scenario, it may be hypothetically possible that If enrollments were ballooning across higher education while discount rates rose, net tuition could have also increased.? However, enrollment contracted for several years in a row, meaning that net revenue likely declined sharply during this period. Prior to the contraction, it grew slowly, and much slower than the rate of increase in discounts. Proprietary research from Ruffalo Noel Levitz (RNL 2023 Discounting Report) shows that net tuition per student at public universities was stagnant over the last seven years.? Individual institutions may have fared well but there is little evidence to show anything but dwindling net tuition revenue across public and private higher education, as a sector.??

How Higher Education Became Miseducated

The current state of discounting and net revenue was exacerbated by trends in funding higher education.? As operational costs grew (contract increases, insurance, maintenance are but a few of these costs), most institutions had few resources outside of net tuition to close the gap.? Although the trend for state appropriations per FTE shows an upward trend since 2012, it has yet to reach the 1997 level in constant dollars. Pell Grants had slight increases over time, which helped some students afford higher costs, and there were some increases in state grants to students across the country.? However, the gap between resources and costs continued to grow, and the main sources filling that gap were student loans and institutional aid.? It is at this point where the miseducation begins.

Financial aid leveraging seeks to fill the gap between resources and costs, strategically positioning the aid amounts to influence the number and quality of students attending the institution.? The background analyses of the current patterns of aid and student yield, the first step in leveraging, always reveal areas where additional funds could be spent to influence enrollment behaviors. Commonly, recommendations are made to increase aid expenditures to increase student yield.? When accepted and implemented, upward pressure is placed on the gross tuition rate (and/or fees) to create the pool of available resources.? This is especially true when there is no endowment or annual gift revenue to support the increased award levels.? An upward spiral of gross tuition, discounts and student loan debt ensues, creating a false picture of actual student costs.

The role of financial aid in enrollment has also been misunderstood.? The aid package presented to a student and her family should seal the deal, not become the deal.? Compared to the expense increases in institutional aid, far too little investment has been made in marketing academic programs, educational experiences and institutional reputation.? When a student perceives the inherent value of the educational experience, the quality of the academic program and its likelihood to generate the outcomes associated with higher education (first and foremost, a solid career and lifetime earnings), they are more likely to pay a greater share of the total cost.? Less discounting is required, as the desire to attain the education is greater.

Discounting was supposed to be a short-term strategy to leverage the position of the institution in the larger higher education market.? By creating greater demand for enrollment, the institution could gain greater tuition revenues from those willing and able to pay them.? This concept was lost in the quest to implement a solution that could quickly turn the tide of dropping enrollments, or to rescue programs that had become too small to sustain.

This is perhaps the greatest miseducation of all - that financial aid leveraging was the strategic solution, rather than one piece of a larger institutional set of coordinated strategies to shift its market position.? To be successful long-term, equal attention must be paid to brand marketing, and especially to the representation of academic programs and educational experiences.? In a landscape where thousands of institutions offer many of the same academic programs, how can a student tell them apart, and why should she pay more for one over the other?? If the only answer is to offer more scholarship dollars or larger grants than the school down the road, the upward spiral will only continue.

What Has to Change?

First and foremost, colleges and universities must communicate what matters to students and families.? How do their academic programs educate students to be prepared for meaningful and fulfilling careers?? What experiences and opportunities set those academic programs apart from others?? How does the institution work to make memorable impressions about academic programs and educational experiences on the website, through verbal and written communications, in a consistent and succinct way?

Today’s college students of every age expect personalization.? They live in a world where information and experiences are tailored to them.? Websites change to reflect their most recent interactions, and communications encourage them to take the next step, rather than presenting a series of generic steps and expecting the student to determine which one is next.? Many colleges excel at creating personal relationships with students once they visit or become admitted.? That is fantastic but too late in the cycle; more personalization is required when students are just beginning to search or to look at the college from afar.

The boldest step may be to identify a consortium of institutions with similar characteristics, in similar geographic regions, and decide to cut gross tuition and discounts.? Individual attempts to do this in the past have often failed, mainly because competitors continued the arms race and offered large institutional aid packages that were based on high tuition rates and unfunded discounts.? Continuing this arms race is fatal to everyone in it.

In 2023, 125 American colleges closed.? Many institutions were overleveraged and lacked net tuition revenue to sustain operations.? It may be time for a new strategic approach to enrollment, focused on resonant content, consistent messaging, and personalization at scale.