"We Can No Longer Cut Costs": Can Colleges Recover from the Inflation Shock?

When St. Catherine University, a small nonprofit university, announced it would close this spring, the California-based university's president attributed part of its financial shortfall to "unusual inflation."

St. Catherine is not alone in making such laments. Over the past few months, the Pittsburgh Institute of Technology, Delaware College of Art and Design, Wells College, and Goddard College also cited inflation or rising costs when announcing their closure decisions.

Even colleges and universities in relatively sound financial health are feeling the pressure of inflation. In a recent budget proposal by the interim president of the University of Minnesota, the word "inflation" was mentioned 25 times, pointing to rising costs for food, services, and labor.

Although higher education inflation has slowed over the past year, college costs remain well above pre-pandemic levels—creating financial strain for institutions that lack the substantial resources to weather difficulties. Yet the need to invest in institutional development persists, exacerbating the predicament these institutions face.

Now, many are essentially saying: "We can no longer cut any expenses. We must invest in our people, staff, and facilities," said Timothy Yates Jr., president and CEO of Commonfund OCIO, which provides asset management services to higher education institutions and other nonprofits. "The cost-cutting part has reached its end."

Calculating college inflation

Over the past roughly 40 years, higher education costs have diverged from overall economic costs. This is one reason the Commonfund Institute calculates its own metric for the sector each year, known as the Higher Education Price Index (HEPI).

Beginning in the mid-1980s, HEPI diverged from the Consumer Price Index (CPI), with higher education institution costs rising faster than CPI in most years.

"We believe it costs more to run a university or college, and while running a household is also important, the two are not comparable," said George Suttles, executive director of the Commonfund Institute.

The largest components of HEPI include personnel costs—salaries for faculty, clerical staff, administrators, and service workers, as well as fringe benefits.

Suttles and Yates noted that colleges and universities use HEPI for budget planning. Endowment fund managers also use the metric to help set investment return targets, which typically need to account for inflation.

Determining the inflation rate that colleges and universities might face is quite important, Yates said.

"Does your endowment need to keep pace with high inflation, or just CPI inflation?" Yates said. "In most cases, CPI does not reflect the cost structure of the institutions we work with."

HEPI vs. CPI trends since 2000

Until recent years, the Higher Education Price Index typically exceeded consumer inflation.

Last year, according to HEPI, the inflation rate faced by higher education institutions was 4%. That figure was lower than the 5.2% in 2022.

In 2022, nearly all cost areas tracked by HEPI grew at rates significantly higher than the previous year. The steepest increase was in supplies and materials, which rose 21.5%. Utilities, a historically volatile category, surged a staggering 43.1%.

The Commonfund Institute estimates that HEPI will grow 3% in 2024, which would bring the metric back to the normal level of higher education inflation over the past decade. However, this also means costs are still rising at a significant pace—and on top of recent spikes.

"Your margins are shrinking"

These cost surges translate into additional financial pressure for colleges and universities, which are already dealing with declining enrollment, budget deficits, and other issues.

For colleges and universities, inflation combined with structural deficits can accelerate cash depletion, noted Chuck Ambrose, senior education advisor at Husch Blackwell law firm. He has served as CEO of multiple colleges and universities.

Rising costs have a more profound impact on smaller, non-elite institutions, which lack the revenue base and endowment to absorb the pressure.

"The universities that haven't been hit as hard are those with endowments," said Stacey Lindeman, a consultant who works with the National Association of College and University Business Officers. "They have a cushion to fall back on. Other institutions, if they don't receive large donations, will be affected."

Take Wells College in New York, for example. In recent years, its spending grew while revenue fluctuated, and it consistently ran deficits. From fiscal year 2021 to 2022, spending increased by nearly 14.9%. In 2023, spending grew another 11%, while revenue fell by more than $1 million, a decline of about 5.4%.

In recent years of surging inflation, businesses in other industries responded to rising supply chain and labor costs by raising consumer prices, at least recovering some of their lost profits.

But higher education may not have that luxury—at least not at this historical juncture.

In a report last year, Fitch Ratings analysts noted that public institutions have kept tuition unchanged and predicted that private university tuition increases would soon slow. For the 2023-24 academic year, the rating agency concluded that "modest" net tuition growth combined with a "challenging inflationary environment" would weigh on margins.

Part of the reason is that the cost of attending college is already painfully high.

"The market's tolerance for continuing to raise the cost of attendance is declining," said Ricardo Azziz, director of the Higher Education M&A Center, during a panel discussion at the annual meeting of the Higher Education Commission this spring. "There is a limit to what American families can pay, and we are approaching that price ceiling."

As back-end costs rise and front-end prices stay flat, one side has to give.

"Your margins are shrinking, or you need to develop organizational efficiency," Lindeman said.

Even if colleges and universities can mobilize resources to invest in themselves, inflation erodes the effectiveness of those investments.

"The market's tolerance for continuing to raise the cost of attendance is declining."

— Ricardo Azziz, Director, Higher Education M&A Center

Facilities spending provides a vivid example. According to Gordian, a construction intelligence company, investment in existing campus facilities grew by more than 26% year-over-year in 2023, a surge the company called "a notable shift" for the industry.

This activity indicates that higher education is gradually addressing its backlog of deferred maintenance and maintaining existing buildings. However, at the same time, inflation in construction services and supplies has significantly eroded these expenditures.

According to Gordian, between 2019 and 2023, operating budgets grew by more than 9.5%, while the cost of construction supplies and services rose 19%.

"Purchasing power has actually declined," the company said in a report earlier this year.

Is there still room for maneuver?

Beyond the challenge of revenue growth, colleges and universities may also be running out of costs to cut.

Meanwhile, trying to keep costs stable at an institution—where costs are often reflected in salaries and benefits—can create morale issues among the workforce, Ambrose said.

"Just maintaining operational integrity is hard enough," he added.

At this point, what can colleges and universities do to manage inflation?

Given the complexity and specificity of cost structures, Lindeman pointed to the importance of what she calls "forensic budgeting."

This involves carefully scrutinizing expenditure items against what they should or could cost, to find potential areas for savings, Lindeman said.

Deep analysis, including working with third-party consultants, can sometimes identify areas where institutions can avoid costs, Lindeman said. This might include situations where "you may not save today, but it's cost avoidance over the next 10 years," Lindeman said. "That really can help your institution."

Often, such strategic budgeting involves reviewing expenditures in terms of potential alternatives, scrutinizing contracts, and delving into every corner of institutional operations to find places where money can be saved.

"Are we locked into contracts signed 10 years ago that are no longer favorable to us?" Lindeman said. "Do we have cost-saving ideas like 'turn off the lights when you leave the room,' or 'do elevator maintenance,' so you don't have an elevator crash costing $1 million instead of $200,000?"

These ideas are often institution-specific, Lindeman added. Depending on the college, costs may be hidden in IT systems and contracts, or in class sizes, or in legal risks that could become future liabilities, or in any other area.

Colleges and universities may also begin seeking external help to reduce costs. Ambrose said he expects more staff positions to be replaced by AI applications and technology, or through industry consolidation.

"The cost-cutting part has reached its end."

— Timothy Yates Jr., President and CEO, Commonfund OCIO

Endowments can also provide relief—provided the institution has an endowment of sufficient size.

"Another lever that colleges and universities have is fundraising and development," Suttles said.

He noted that larger, more mature fundraising operations might try to structure gifts and payout structures to "get more actual money" more quickly.

Given the long history of persistently high and sharply rising higher education costs, fundraising has been used as a hedge against inflation, providing scholarships and aid for students who cannot afford the high cost of attendance. In this sense, inflation is embedded in the fundraising process in the same way as endowment return targets.

According to Suttles, colleges and universities can attract donors by highlighting the impact of inflation in their messaging. They can say, in effect, "'We are working to ensure that the college experience remains affordable for future generations,' and that resonates with people."