Far Eastern University Gil Puyat Avenue, Makati City

Piedmont University

Case Study

Submitted By:

Djoane Pauline Marie P. Guitguiten

Sharon Cruz

Brief Background of the Case Study

When Professor Scott became the president in 1984, the university was facing declining

enrollment and increasing cost.

The deficit resulted from using the principal of quasi-endowment funds.

Professor Scott instituted measures to turn the financial situation around:

- Raised tuition.

- Froze faculty and staff hiring.

- Reduced operating cost.

In 1986, Mr. Malcom Piedmont alumni and partner in local consulting firm, volunteered to

examine the situation and offered the following recommendations:

Increased recruiting and fund raising activities.

Recognized the university into a set of profit centers.

At the time the principal means of financial control was an annual expenditures

budget submitted by the dean of each school and other support departments

heads.

Malcom proposed that the deans and other department administrators would be

responsible for both revenues and expenditures of their activities.

Issues and Questions to Address

1. How should each issues described above be resolved?

2. Do you see other problems with the introduction of profit centers? If so, how would you

deal with them?

3. What are the alternatives to a profit center approach?

4. Assuming that most of the issues could resolved to your satisfaction, would you recommend

that the profit center idea be adopted, or is there an alternative that you would prefer?

Case Analysis

The idea of profit centers in universities dates back many decades, probably to President A.

Lawrence Lowell's dictum to the Harvard deans: Every tub on its own bottom. Although he did not

use the term profit center (and for selling purposes this term may create resentment on the part

of faculty and deans), he clearly meant that each school's revenues should be adequate to pay for its

operating costs. This idea continues to influence the management control system at Harvard and is

increasingly being considered by other universities.

The case provides an opportunity to discuss the principal problems that arise in implementing a

profit center structure, and the situations described range from those for which a strong case can be

made to those for which the results would be clearly dysfunctional.

The case also permits a discussion of certain behavioral problems in management control: the

danger that management runs in accepting an offer from a well-meaning, but perhaps not skilled,

volunteer and the difficulty of finding a graceful way of declining such help; the proper approach to

gaining acceptance of ideas; the indication that a strong-minded president can turn an organization

around, especially during a honeymoon period when the seriousness of the situation is recognized.

Answers to the Questions of the Case

Q1. How should each issues described above be resolved?

General administrative costs.

Charging these costs to individual schools would result in an operating statement that would

report the extent to which the school's revenues were adequate to pay for its own costs plus

a fair share of the central costs. The sum of the net incomes reported for each school would

be the net income of the university. This charge might get the deans to recognize that the

university necessarily incurs costs on their behalf, which must be met from some source. The

practice might also cause the deans to question whether the central costs were too high,

which would be one way of exercising control. Perhaps the central administration would be

reluctant to tolerate such questions.

An alternative is to not charge these costs, or to charge only those that can be specifically

identified with a given school (such as accounting, purchasing, personnel). This would reduce

the technical and behavioral problems associated with the allocation of indirect costs.

Any basis of allocating indirect costs can be criticized because there is no scientific way of

doing this, by definition. The criticism that the administration probably spends more than a

proportional amount of time on the undergraduate school is probably justified, but there

does not seem to be a feasible way of correcting this inequity.

If these costs are charged, the charge should probably be a budgeted amount, rather than

the actual costs incurred. Allocating actual costs permits the central administration to pass

costs that are greater than budgeted to the individual schools.

Gifts and endowment.

The deans quite naturally would not favor giving the president authority to distribute $7

million as he chooses. Actually, the process would require that the schools put in their

requests and the president allocate the funds in a way that causes the minimum amount of

dissatisfaction. The president could not allocate the funds in a way that is perceived to be

grossly unfair; he would lose the support of the deans if he did this. Moreover, the each tub

on its own bottom idea can't work perfectly. The theological school, for example, does not

cover its costs by some $3.1 million (Exhibit 1), whereas the business school has a surplus of

$4.2 million, reflecting the attractiveness of its program to donors, the ability of its students

to pay tuition, the need for financial aid, the opportunity to obtain research grants, and so

on.

The business school surplus can lead to a discussion concerning the question of whether the

president should have the authority to allocate such surpluses to other schools. Currently,

this is a hot topic in many universities. Also, if it is decided that the library should not

generate its own revenue, the central administration must make up the shortfall.

This topic provides an opportunity to discuss the question: should each part of an

educational institution pay its own way? Carried to the extreme, less popular courses (Latin,

Greek, advanced seminars) would be eliminated, even though they may make an important

contribution to the university's total reason for being. Few would argue that each course

should pay its own way, and by extension, the argument can be made that certain schools

should be subsidized. On the other hand, if a given school does not obtain resources

sufficient to cover its costs, questions can be raised occasionally (not every year) about the

desirability of condoning it.

Athletics.

Overall, this is one of the less sensible of the consultant's proposals. A case can be made for

charging a fee for scarce resources (such as tennis courts, golf courses, or ski lifts) as a way

of rationing these resources (but the case is not particularly strong). Presumably, however,

the university wants to encourage intramural athletics, and charging a fee would not

indicate such encouragement. The rationing argument is not applicable to intramural

athletics. Also, there is an indication that intramural and individual athletics should be asked

to subsidize intercollegiate athletics, which does not make much sense.

Maintenance.

Permission for schools to use outside contractors is an important aspect of this proposal.

The maintenance department's concern about the decline in maintenance quality has some

merit, but it should be possible to exercise adequate quality control. The maintenance

department should be given the authority to do this.

If schools can use outside contractors, the maintenance department must compete with

them, which tends to motivate it to be efficient. It must control its costs and obtain enough

work so that it breaks even, or there is an indication of poor management or that the

department is too large. There should be a proviso that if the maintenance department is

willing to do the work at not more than the outside price, it should be given the job.

Furthermore, if the schools are not permitted to go outside, they are at the mercy of the

maintenance department with respect to the priority of meeting their requests and the

amounts spent. The pros and cons for maintenance are also applicable to other support

departments: purchasing, accounting, and aspects of the personnel department (but not

university personnel policy).

Computers.

A few years ago, many colleges and universities did not charge students and faculty

members for the use of computers (except possibly for faculty members working on cost-

reimbursable contracts). The primary reason was that they wanted to encourage the use of

computers. The tendency now seems to be in the other direction with respect to mainframe

computers, on the grounds that the usefulness of computers is now generally recognized;

the practice of charging for computer usage is by no means universal, however. (It is

somewhat ironic that many universities keep careful controls over the use of postage and

long-distance telephone cards, which involve much less cost than computers.)

Probably most computer work within a school, especially work done on personal computers,

is done without charge. The issue here, however, is charging for work done on the

engineering school computers by faculty and students at other schools. Assuming that

usefulness is adequately recognized, the arguments here are essentially the same as those

for maintenance.

A special circumstance about computers is that they have software that can supply detailed

information about usage at low cost, so recordkeeping cost is not as important a factor as is

the case with some of the other services discussed in the case.

I doubt that time will permit the class to get into the details of how a charge should be

calculated. There is much discussion about this in the literature: a low charge for off-peak

usage; a charge for setup time and assistance from computer personnel that is separate

from the charge per minute of running time; a charge for plotters and other peripheral

equipment; and so on. There may be advantages in detailed, possibly elaborate, charging

systems; the question often is whether they are worth the cost.

Library.

This is the extreme case of a situation in which charging for services rendered is likely to be

counterproductive (but an outside consultant may not appreciate this). The university wants

to encourage library usage, and charging a fee would tend to have the opposite effect. As

the case states, the recordkeeping involved would be considerable, with thousands of

transactions, each involving only a few pennies of cost. (As is the case with computers,

library costs might be charged to cost-reimbursable contracts, but the charge can be arrived

at by approximations derived from sample tests or other methods that are less expensive

than keeping detailed records.)

Cross registration.

On the one hand, it can be argued that if a course is offered, a few additional students do

not cause any increase in costs. The argument against this is that a fair share of the cost of

the course should be charged to each student, more specifically to the school from which

the student comes. Opinions will differ as to the relative weight to be given to each side of

the argument There is also the question of whether such a charge has a motivating influence

on either the school from which the student comes or the school in which the class is

located. If a charge is made, the method suggested in the case seems reasonable, with the

possible exception that tuition may be considerably lower than the real cost of education,

with the difference being made up from gifts and endowment earnings.

Q2. Do you see other problems with the introduction of profit centers? If so, how would you deal

with them?

Probably the difficulties with profit centers will come up in the discussion of question 1, and

this question is intended merely as a means of catching gaps. In particular, the bad

impression given by the term profit center should not be minimized; charging for services

rendered is a more acceptable way of putting it. The taste of educating people when a new

system is introduced should not be minimized. In particular, there tends to be friction and

more arguments about how the charges are to be calculated than is warranted. Senior

management should try to keep these arguments from becoming acrimonious. Otherwise,

the deans and faculty will claim that the university is now being run for the benefit of

accountants.

Q3. What are the alternatives to a profit center approach?

One alternative to the profit center approach is, of course, to keep the present system. The

pros and cons of this should come out in the discussion of question 1.

Students may propose other alternatives. It would be possible to charge certain expenses to

the individual schools for information purposes, but not include them in the formal budgets

nor make the corresponding credits to the departments that furnish the services. The idea

would be to give the schools a better idea of the real cost of their operations without the

work and possible friction that arises when these costs and revenue are included in the

formal accounting system. This proposal, although similar to actual practice in some

organizations (including the federal government), does not accomplish much. Without the

motivation provided by inclusion of these costs in their budgets and the requirement that

they live within these budgets, deans are unlikely to pay much attention to these

memorandum records.

Q4. Assuming that most of the issues could resolved to your satisfaction, would you recommend

that the profit center idea be adopted, or is there an alternative that you would prefer?

The discussion of this question can get bogged down because of differences in the

recommended treatment of the issues in question 1. It may be well to avoid it by asking for a

resolution of each of these issues and then debating the question of whether this consensus

presumably the most desirable application of the profit-center idea is better than the

alternative.

We would definitely charge for maintenance work and similar support services (including the

support functions of the central office). We would give the president authority to parcel out

undesignated gifts and endowment earnings. We would probably charge for the use of the

mainframe computers. We would probably not charge for tennis, golf, and skiing in order to

ration scarce resources (on the grounds that a sign-up system is a better way of rationing).

We would not charge for intramural athletics or for the library. We would charge for cross

registration only if there was a substantial amount of it with the net transfers not washing

out. Otherwise, the recordkeeping costs would exceed the benefits.

Also, we would not ask the deans to approve the proposal, or any part of it, as it comes from

an outside consultant. We would say that the consultant's proposal was submitted solely to

stimulate discussion. The weaknesses of certain aspects of the proposal are so apparent that

the whole idea may be rejected. Having had the initial discussion, we would assign the job of

developing a new proposal to someone in the administration (or possibly to a committee) so

that the next version would be given to the deans as coming from within the institution and

taking account of their concerns. If handled properly, we hope that the deans' reaction

would be: we had an unrealistic proposal from a consultant which the president wisely

rejected; we now have a practical one that is worth taking seriously.

Lessons Learned

There are special considerations in Management Control Systems for service

organizations.

Performance in profit centers is judged by the criteria of efficiency and effectiveness.

Effective Management Control System should include:

Good reporting system.

Balance scorecard linked with reward system.

Fair transfer price.

Goal congruence to meet strategic objectives.