Competition in the Higher Education Industry

December, 2014

Introduction

In recent years, especially since the onset of the great recession, there has been much debate about reforming higher education. The industry has been the subject of much criticism—both for its escalating prices and its apparent aversion to adapt to emerging technological realities. There is a widespread sense that the level of competition among higher education institutions is increasing at local, national, and global levels. Participants in this ongoing conversation may find themselves inclined to analyze college and university operations using standard business constructs. However, this approach may be unproductive. In fact, there is evidence to suggest that colleges and universities operate under very different economic terms than for-profit enterprises.

This paper will assemble insights from research, analysis, and critique published over the past 15 years, showing that much of higher education compulsively pursues the elusive aim of prestige without regard for escalating costs. Nonprofit status, which has historically dominated the industry, tends to isolate colleges and universities from market realities. Under these conditions, competition often fails to benefit the consumer. The body of the essay is divided into three parts: (a) a survey of the distinctive economics of higher education; (b) an overview of four realms within which colleges and universities compete; and (c) an explanation of the prisoner’s dilemma that arises from positional competition. The paper concludes by suggesting some paths that could mitigate the negative outcomes of the current competitive situation.

The Distinctive Economics of Higher Education

In 1999 Gordon C. Winston published a seminal article on the economics of higher education. His analysis, based on empirical data from thousands of U.S. colleges and universities as well as secondary literature, provides the theoretical foundation for this paper. Significantly, Winston reported that institutions of higher education are generally distinct from businesses on the following counts:

  1. Most colleges and universities are organized as nonprofits, and thus cannot legally distribute their profits. This arrangement is supposed to engender public trust in the industry’s responsibility to deliver a needed service in a context of strong information asymmetry. By definition, then, managers of nonprofits are not motivated by profit-making opportunities. What appears to motivate college and university leaders is the pursuit of excellent quality and equity in the provision of service. This tends to promote behaviors oriented toward the maximization of institutional prestige. Colleges and universities can be characterized as “donative-commercial nonprofits” (p. 16); that is, they are dependent on funding from government and charitable donors as well as revenue from customers. This financial model allows them to sell their services at prices that are consistently below cost.
  2. Colleges and universities are distinct from most other industries in that their production technology is often based on peer effects. This means that the quality of their output depends to an extent on the quality of the customers that they attract. Students do not only learn from their instructors; they also learn from other students. In an effort to secure the strongest peer effects, many institutions seek to attract an excess of demand that allows them to practice selectivity in admissions. The desire to achieve high demand creates incentives to invest heavily in prestige-building.
  3. There are thousands of postsecondary institutions in the United States. While they are all part of the higher education industry, they diverge widely in the extent of the donative resources at their disposal. Relatively wealthy institutions are able to invest in a wide variety of academic and other resources to attract high-quality students and provide ideal opportunities for learning. In essence, well-endowed institutions compensate well-qualified students with subsidies that lower the net price of obtaining an education. Institutions with comparatively scant resources offer a more basic array of services. Therefore, as Winston observed, “Competitive forces will still play out, but they will do so on a strikingly uneven playing field” (p. 18).

Realms of Competition

According to Brewer, Gates, and Goldman (2002), higher education institutions compete in four revenue markets: student enrollments, research funding, public fiscal support, and private giving. This section of the paper will survey each of these realms of competition in turn.

Student Enrollment

Students are an essential input to education. Colleges and universities cannot accomplish their teaching mission without recruiting learners. At least to some extent, it is fair to view students as customers, as their college choices have direct economic ramifications. Slaughter and Rhoades (2005) attributed the perception of student as consumer to the marketization of federal financial aid in the early 1970s. With federal funding following students in the form of grants and subsidized loans, colleges and universities have strong incentives to entice students to enroll. Institutions accomplish this not only by developing effective learning environments and offering curricula in fields with strong labor demand, but also by providing extras such as athletic teams, beautiful campuses, desirable living spaces, and the like (Mills, 2002). Clearly, then, colleges compete for students. Interestingly, according to Winston (1999), the nature of competition varies based on an institution’s place in the prestige hierarchy: “At the bottom, it’s competition in the product market for customers who will buy the output; at the top, it’s competition in the input market for scarce student . . . quality that will improve a school’s educational quality and position” (p. 30).

Research Funding

A second domain where many, but not all, institutions compete is that of research funding. Some institutions, such as technical schools and community colleges, have a mission dominated by teaching. Research universities, on the other hand, are heavily oriented towards research that is often costly, and thus only capable of being carried out with external funding. Regardless of whether research funding comes from the government or another source, the process of securing it is competitive: “Such awards are often based partly on peer review, in which other experts and researchers judge the quality of the proposal and advise the funding body as to which proposals have the most scientific merit” (Mills, 2002, p. 129). In recent decades, universities’ involvement in developing new technologies has led to intellectual property competition—namely, in the form of patents and copyrights (Slaughter & Rhoades, 2005).

Public Funding

Public institutions do not simply collect government funding via students’ financial aid packages. Rather, as Mills (2002) has noted, “They can seek direct appropriations through the budget-approval process. In these circumstances, institutions use their influence and political connections, rather than their research expertise, to secure funding for special projects” (p. 129).

Private Donations

Colleges and universities that hold nonprofit status compete for private donations. According to Winston (1999), alumni and other charitable donors may be motivated to give by any of a number of factors. By supplementing their commercial revenues with donations, nonprofit colleges and universities are able to do what is unimaginable in the for-profit arena: subsidize the cost of their services. Top-tier institutions have amassed substantial wealth through private donations, enabling them to circumvent conventional market forces.

Positional Competition: Quality, Prestige, and Reputation

Pak (2013) noted that though universities compete in many arenas, “all of this is meant to contribute to one final objective, which is to preserve or improve their standing. It is in terms of prestige, in other words, that the final score-keeping is done in higher education” (p. 280). Far from claiming this as an original insight, Pak traced it as far back as a book published in 1918.

The Intangible Nature of Quality in Higher Education

According to Pak (2013), “A truly constructive method for measuring the performance of universities is still an ongoing project” (p. 284). This feature of the higher education industry leads to perverse economic effects, as discussed by Martin and Gillen (2009). Since educational quality is so difficult to assess, institutions compete on reputation. Building or maintaining reputation requires money, leading to compulsive spending. The public comes to view price as a surrogate for quality. Nonprofit status complicates the situation, as costs always rise toward the level of available revenue. Furthermore, there are few constraints on the principal-agent problem within higher education.

To varying extents, then, higher education institutions compete for prestige—something much less tangible than the four inputs discussed in the previous section. According to Winston (1999), measures of prestige are typically positional; in other words, they rely on comparisons between institutions. Ranking systems have progressively emerged as measures of quality and prestige. There are numerous systems in use, differing in programmatic, institutional, and geographic scope. Though controversial, rankings are seductive. Institutions consider them important and make strategic adjustments in order to maintain or enhance their position. However, despite institutions’ efforts to move up in the rankings, past perceptions of quality tend to perpetuate themselves over time, and there is little change in top rankings (Clarke, 2002; Cutright, 2002; Tobolowsky, 2003; Devinney, Dowling, & Perm-Ajchariyawong, 2008).

Prestige vs. Reputation

Brewer et al. (2002) developed a typology of higher education strategies that distinguished between prestige and reputation. Both of these convey information that “allows customers to evaluate better the extent to which the institution will be able to satisfy their demands” (p. 27). Reputation, which can be positive or negative, “is based on [the institution’s] ability to respond to the demands of customers and demonstrate that it is meeting those demands” (p. 28). It can accrue and erode relatively quickly. By contrast, prestige is uniformly positive and relatively intangible. “Institutions possessing a high level of prestige often cannot demonstrate that they have met identifiable customer needs. What they can demonstrate is the acquisition of things that tend to be associated with exceptionally high-quality service” (p. 28). Prestige takes a long time to accumulate, but once it has been gained, it erodes slowly.

The distinctions between reputation and prestige led Brewer et al. (2002) to classify institutions into three basic categories: prestigious, prestige-seeking, and reputation-seeking. In contrast to institutions focused solely on maintaining a positive reputation in the market, prestigious and prestige-seeking institutions invest substantial resources to achieve or maintain competitive position in one or more of three key areas: “student quality, research, and sports” (p. 31). Given the difficulty of quantifying prestige gains objectively, institutions aiming for prestige tend to focus on emulating the behaviors of other institutions deemed to be prestigious. Fuller (2012) reported on a study of the peer institutions that 1,600 colleges selected via the Integrated Postsecondary Education Data System. Aspirations for prestige were evident in the following finding: “The typical college selected a comparison group of 16 colleges with a higher average SAT score and graduation rate than its own, lower acceptance rate, and larger endowment, budget, and enrollment.”

Escalating Competition for Prestige: A Prisoner’s Dilemma

According to Pak (2013), prestige competition paradoxically leads not to innovation and customer value, but to institutional convergence and risk avoidance:

To sum up, even in a competitive higher education system like the American, universities have been known to keep spinning their wheels when left to their own devices . . . instead of making a genuine movement forward. This is because the top-tier institutions would not lead, and the lower-tier institutions usually follow the lead of top-tier institutions.” (p. 282)

Winston (1999) reached a similar conclusion, stating that “the players become trapped in a sort of upward spiral, an arms race, seeking relative position” (p. 30). He went on to make this observation:

Any school could opt out of that arms race, unilaterally, only at the risk of being overtaken by hungry schools from below, an institutional sin bordering on fiduciary irresponsibility. So we’ve seen perpetual and ever-larger capital campaigns and real tuition increases despite a bonanza of unprecedented endowment earnings from the stock market boom. In a positional market, there's never too much of a good thing—or even much stomach for asking that question—and in the hierarchy, wealth is quite fundamentally a good thing. (p. 31)

What Winston (1999) and Pak (2013) have described is, in essence, a prisoner’s dilemma. Froeb, McCann, Shor, and Ward (2014) defined this as “a game in which conflict and cooperation are in tension; self-interest leads the players to outcomes that no one likes” (p. 293). The prisoner’s dilemma is, according to Salvatore (2012), associated with oligopolistic market structure. At first glance it may appear that the higher education industry, with thousands of institutions in the United States alone, does not qualify as an oligopoly. However, as Winston (1999) observed, colleges and universities’ direct competitors are limited by the subsidy hierarchy as well as geographic and ideological factors.

When a significant number of higher education institutions become locked into the prestige game, consumers lose. According to Callan (2010), many higher education leaders have come to regard the relationship between educational costs, access, and quality as an iron triangle—a zero-sum game in which gains on one front come at the expense of one or both of the other elements. With prestige being associated closely with quality, colleges and universities tend to pursue improvements in (perceived) quality, even if at higher costs. However, consumer opinion of the higher education industry has suffered as the price of obtaining a college education has risen persistently at a rate higher than household income.

Conclusion

For all its insight, Winston’s (1999) research offered little hope of a solution to the dilemma described in this paper—alternately referred to as an arms race, a prisoner’s dilemma, or an iron triangle. One may infer from his analysis of financial aid offers that changes in government policy might lead to better outcomes. In Martin and Gillen’s (2009) judgment, breaking the cost spiral will require more objective measures of quality, relating to teaching as well research. It will also require changes in the incentive structure within which colleges and universities operate, thus involving accreditation reform.

It is difficult to envision a scenario in which prestigious institutions, those that benefit from the status quo, will voluntarily abandon the costly race to achieve ever-greater levels of prestige. Perhaps the strongest hope for improved performance within the higher education industry (i.e., lower costs combined with greater quality and broader access) lies in market forces. In the eyes of some analysts, higher education is vulnerable to disruption by innovative providers who are willing to provide services at a more reasonable cost (Christensen, Aaron, & Clark, 2002/2003). While a number of lower-cost models have emerged in recent years, often leveraging emerging technologies, it remains to be seen how quickly or pervasively they will alter the landscape of higher education. In the meantime, those who would seek to reform higher education will do well to understand the complex economic realities that make it difficult for colleges and universities to fulfill their potential within society.

References

Brewer, D. J., Gates, S. M., & Goldman, C. A. (2002). In pursuit of prestige: Strategy and competition in U.S. higher education. New Brunswick, NJ: Transaction.

Callan, P. M. (2010, March 23). The politics of disappointment. Inside Higher Ed. Retrieved from http://www.insidehighered.com/views/2010/03/23/callan

Christensen, C. M., Aaron, S., and Clark, W. (2003, January/February). Disruption in education. EDUCAUSE Review, 38(1), 44–54. Retrieved from http://www.educause.edu/ir/library/pdf/ERM0313.pdf (Reprinted from The Internet and the University: Forum 2001, pp. 19–44, by M. Devlin, R. Larson, & J. Meyerson, Eds., 2002, Boulder, CO: EDUCAUSE)

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Devinney, T., Dowling, G. R., & Perm-Ajchariyawong, N. (2008). The Financial Times business schools ranking: What quality is this signal of quality? European Management Review, 5(4), 195–208. doi:10.1057/emr.2008.14

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Fuller, A. (2012, September 10). In selecting peers for comparison’s sake, colleges look upward. The Chronicle of Higher Education. Retrieved from http://chronicle.com/article/In-Selecting-Peers-for/134228/

Martin, R., & Gillen, A. (2009, August 7). Breaking the cost spiral. Inside Higher Ed. Retrieved from http://www.insidehighered.com/views/2009/08/07/martin

Mills, M. (2002). Competition. In J. J. F. Forest & K. Kinser (Eds.), Higher education in the United States: An encyclopedia (Vol. 1, pp. 128–130). Santa Barbara, CA: ABC-CLIO. Retrieved from http://search.ebscohost.com.proxy.missouristate.edu/login.aspx?direct=true&scope=site&db=nlebk&db=nlabk&AN=83351

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Salvatore, D. (2012). Managerial economics in a global economy (7th ed.). New York: Oxford University Press.

Slaughter, S., & Rhoades, G. (2005). Markets in higher education: Students in the seventies, patents in the eighties, copyrights in the nineties. In P. G. Altbach, R. O. Berdahl, & P. J. Gumport (Eds.), American higher education in the twenty-first century: Social, political, and economic challenges (pp. 486–516). Baltimore: Johns Hopkins University Press.

Tobolowsky, B. F. (2003). College rankings. In J. W. Guthrie (Ed.), Encyclopedia of education (2nd ed., Vol. 1, pp. 378–381). New York: Macmillan Reference USA.

Winston, G. C. (1999). Subsidies, hierarchy and peers: The awkward economics of higher education. The Journal of Economic Perspectives, 13(1), 13–36. Retrieved from http://search.proquest.com.ezproxy.liberty.edu:2048/docview/212070866

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