What is tuition discounting and why do colleges do it?

Tuition discounting is growing in higher education. Yet, by the very nature of the practice, the concept is confusing to prospective students as well as people who have spent their careers working in colleges and universities.  A recent report by the National Association of College and University Business Officers (NACUBO) suggests that tuition discount rates are at an all-time high. The report further argues that the strategy is unsustainable and many institutions will have to reconsider their approach to discounting. But all of this raises the question: what is tuition discounting and why do colleges do it?

Photo credit: Daniel Oines

No one— or very few students— actually pays the listed tuition price for a university. The way to think about a university’s tuition is like the sticker price on a car. No one pays sticker. The question is how much of a discount you can negotiate.

In higher education, the way this works is that universities use institutional funds to offer students a discount on the tuition sticker price. Most of the funds used to discount come from tuition that essentially reduces the net revenue to the institution.

So a real world example:

A university has a sticker tuition price of $25,000 and offers a student a scholarship of $6,250.

Using this example, the university has discounted tuition 25% and the student pays $18,750.  Thus, the net revenue to the university is $18,750 even though the tuition price is much higher.

Note: I said the institution offered a scholarship because this is often how discounting gets packaged. Students want to hear they were awarded a scholarship than simply a price break on tuition.

From an institutional perspective, the two numbers that you want to look at closely are the tuition discount rate (the average percentage discount offered) and the net revenue. Ideally, you want to see the discount rate going down and the net revenue number going up. This suggests that students are interested in the university and willing (or more accurately) able to pay a higher tuition amount.

According to the NACUBO survey, the average discount rate is much higher than my 25% example. The average private college discount rate was 48% in 2014, an increase from 46.4% in 2013.

Using the same example from above with the higher rate, you can see how this can hurt an institution financially.

The university has a sticker price of $25,000 and a 48% discount rate. On average, a student receives a $12,000 scholarship and pays $13,000.

On the surface, it might seem this isn’t so bad. The student saved a few thousand dollars in tuition.  That’s a good thing, right?

But let’s assume the university enrolls 2,500 students. Each percentage point increase in the discount rate is $625,000 in lost revenue.

Of course, things are more complicated than this because the university likely wouldn’t be able to enroll 2,500 students without the discounting.

In this way, universities operate along the same lines as an airline. There are fixed and marginal costs for a seat on an airplane, but the marginal costs are pretty small for each additional passenger. As a result, even if they have to sell the seats at a deep discount (last minute fares), the airline is better off with a full plane.

In the same way, the marginal costs to enroll an additional student are pretty small certainly relative to the fixed costs of a university. As a result, universities are better off discounting to ensure they enroll a full class.

It is important to note that this is a financial strategy primarily used by private universities. In a positive sign for attempting to maintain access, the NACUBO study found that most of the discounting funds went to students with the most financial need. Although, it is obviously concerning that students and families are struggling so much with the ability to pay higher tuition levels even as the economy has improved— clearly the economic recovery hasn’t reached everyone.

To the extent that public universities participate in discounting, they largely do so using merit-based aid to reduce the price for the highest ability students. The logic goes that the sticker price is much lower thanks to state subsidies so we can allocate our funds for merit. However, public universities have seen their tuition increase substantially in recent years.

At the same time, public universities have started to recruit out of state students who pay higher tuition rates. What public institutions that are focusing on nonresident enrollment are doing is offering discounts on out-of-state tuition to entice a nonresident student to attend. Even with the discounts, the net revenue of these students is higher than in-state students. In effect, they are starting to follow similar practices to their private counterparts.

Overall, there are many critics of tuition discounting as the concept is confusing and hides the true price of higher education from students. In addition, many students don’t understand that the tuition price is like a car sticker price and immediately cross a university off their list as too expensive. However, given the financial situation that many institutions face today, tuition discounting allows them a vehicle to maximize their net tuition revenue.

As we move forward, my hope is that we can find a way to balance both of these competing ideas and figure out how to protect the financial interests of both students and institutions. In the meantime, I hope this helps explains what tuition discounting is and why colleges do it.

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