Optimizing Institutional Budget Models

Strategic Lessons for Aligning Incentives and Improving Financial Performance

Topics: Academic Affairs, Budgeting, Administration and Finance, Budget Models and Cost Allocations, Debt Management, Facilities and Operations, Space Utilization, Revenue Enhancement, Tuition and Fees, Library, Research Enterprise, Strategic Planning

Budget Design Principles

More Than Dollars and Cents

Executive lessons for budget model design

Budgets are “the surest single indicator” of what a university is committed to doing. Beyond simply allocating revenue and costs, budgets can reinforce and even define an institution’s priorities and commitments.

Yet many institutions’ budgets fail to do so, reinforcing the wrong objectives, or no objectives at all. In too many cases, university budgets lock in damaging cost structures, underfund strategic priorities, or create harmful campus incentives. It is imperative that institutions think critically about how their resource allocation choices reinforce (or obstruct) their priorities.

To build a more intentional budget model, institutions should consider how individual elements of their budget process can be redesigned to incentivize revenue growth and cost control, set performance targets, and fund strategic priorities. To help lead more productive conversations, this section details four lessons for designing institutional budget models.

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Lesson 1: Let Institutional Goals Drive Revenue Allocation

Matching control and authority

The first budget design lesson is that institutional goals should determine how the budget model allocates revenue.

Seeking new revenue, more colleges and universities are considering incentivizing academic units to grow by allocating them a share of the revenue they generate. However, allocating all revenue to units versus retaining all revenue centrally is a false choice. Instead, institutions should first consider what type of revenue they want to grow and then select an allocation method that creates an incentive for the behavior they want.

Some types of revenue can be greatly impacted by academic unit leaders, and greater allocation can incent meaningful growth. Others cannot be easily inflected by academic units and are more logically kept under central control.

Expanding Professional Master’s programs, for example, is contingent on academic leaders’ cooperation. Allocating units a share of revenue from the new program provides incentives for leaders to support growth. On the other hand, academic leaders have little control over state appropriations, so allocating these funds to units has less impact.

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Common Methods to Allocate Revenue to Units

The best allocation method to create incentives for growth depends on the type of revenue. The nine distinct mechanisms institutions can use are listed here, organized by the type of incentive leaders want to create.

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Lesson 2: Keep Cost Allocation Metrics Simple

Charge ahead?

The second budget design lesson is to keep cost allocation simple. Distributing overhead costs at a college or university is difficult because most institutions lack the activitybased accounting tools required to calculate an individual unit’s precise share of overhead.

For select services, such as classroom space or utilities, directly metering each unit’s usage is an appropriate strategy. These services are both readily measurable and resources most leaders want to better ration across campus. In most instances, though, metering has little or no impact, as services provide broad institutional benefits and costs are mostly fixed.

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Diminishing Returns to Complexity

USC simplifies cost accounting to improve acceptance

For costs where metering is not possible, the simplest allocation formulas have proven most effective.

As an example, when the University of Southern California implemented RCM in the 1980s, administrators created over 100 unique cost allocation formulae to distribute nearly every line item on the university’s budget to colleges. The system required significant effort to manage, and unit leaders found the model confusing and frustrating.

In the mid-2000s, leaders moved to a radically simplified approach based on only four cost categories, with each unit’s charge determined by a single, easy-to-understand metric.

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Common Metrics for Major Expense Categories

Other institutions have successfully adopted similarly simple approaches to cost allocation. Typical metrics used to allocate major categories of institutional costs are listed here.

Charging units a tax on the revenue they generate is the most common approach, followed by charging units based on the share of faculty they employ or students they teach.

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Lesson 3: Incorporate Performance Targets into Budget Allocations

Accounting for performance

The third lesson is to formally incorporate performance targets and institutional goals into the budget.

Through the budgeting process, leaders should agree to concrete performance targets and the funds necessary to ensure success in each of the three areas listed here.

First, although the strategic plan is the most visible expression of an institution’s priorities, the budget should refine and operationalize the strategic plan by defining tangible priorities and performance targets.

Second, budgets can enforce performance targets around student success by linking budget allocations to student outcomes or by allocating funding for performance incentives.

Third, margin targets serve to define financial performance benchmarks to protect institutional resources.

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Budgeting in an Era of Change

Compendium of Budget Elements