How to Drive Value from RCM Without Adopting an RCM Budget Model

Show Me the Money: How to Drive Value from RCM Without Adopting an RCM Budget Model

Higher education institutions rely on a wide variety of approaches to manage their budgets, from a centralized system of in- cremental budgeting to a decentralized Responsibility Center Management (RCM) budget model, with many other options and hybrid approaches in between. You may be one of the many universities still using more traditional incremental budgeting approaches because of its simplicity and ease of use. If so, then you likely run into issues with financial transparency and being able to fully support and validate strategic decisions with accurate financial data. To overcome this, some large universities have moved to RCM budget models, which provide individual units with more autonomy and increased transparency. Although this approach is complicated and not right for everyone, the principles used in RCM budgeting can be applied in more traditional budget model environments to increase transparency without adding complexity.

In this article, we will provide an overview of the different budget model options and how you can take the best of both approaches to improve your operations and strategic decision making.

What is incremental budgeting? to make fully-informed strategic decisions about where to allocate or reallocate funds. Should I still use it? What about the RCM budget Incremental budgeting refers to building a new budget based on the budget from the prior period, usually by making mar- model? Would that work better ginal adjustments up or down from previous budget values. The actual budget design usually happens at the broad, insti- for me? tutional level, and when overall expected revenue increases RCM budgeting refers to delegating operational budget au- or decreases, these changes are generally felt across the orga- thority to schools and other revenue-generating units within nization. This model is popular among universities due to its a university. Each unit has some level of autonomy over its simplicity, ease of implementation, and the resulting budget- own revenues and expenses, more similar to a traditional ary stability, which allows for easier unit-level planning. corporate P&L. A school / department will collect its own tuition, the rec center will receive its portion of the student However, incremental budgeting can obscure implicit fee, etc. Generally, revenue-generating units are responsible university investments that were strategic at one point, but for paying for their own direct expenses (e.g., salary costs, have been lost or forgotten over the years. For example, the supply costs, scholarships), as well as their portion of univer- Engineering School may have seen an increase in their oper- sity overhead expenses (e.g., facilities costs, central HR costs, ating budget to support substantial maintenance and repairs central IT costs). The RCM model provides greater trans- necessary in their old, crumbling building five years ago. parency into the financial health of each unit and empowers After moving into their new building, however, with little unit leaders to make the best use of limited financial resourc- maintenance required, they did not see a budget decrease, es, encouraging innovation and efficiency. because the investment decision had been forgotten.

However, the devil is always in the details, and implementing Over the years, the appropriate cost of operating each indi- RCM can be politically difficult and create new challenges vidual unit often deviates from its budget, so central univer- for the university. sity decision-makers don’t know the true financial health of each unit. This makes it difficult for university leadership THE IMPORTANCE OF CHANGE as English or Psychology. RCM can make it more politically MANAGEMENT challenging, if not impossible, for “profitable” programs to subsidize other programs that are more costly. The RCM model is complex and can be challenging to initially implement and get right. When making the switch Although there are benefits to any RCM model, the chal- to RCM, there will be winners and losers for each of the lenges may prove too much for some institutions without allocation methodologies for revenue and overhead expens- autonomously-operating units. In particular, smaller-scale or es, and the political battles can be intense. For example, the centrally-managed universities may find the complexities of Law School may face a reduction as a result of the new RCM the RCM model impractical and counter to their culture. model, which can lead to entrenched resistance from the Dean and other Law School senior leaders. How can I achieve THE NEED the financial trans- Budget model analysis results in a quasi-P&L for each unit. FOR GOVER- At one university, international education was a presidential parency of the NANCE AND strategic priority, but financial and executive leadership did RCM model, but DECISION not understand the magnitude of the investment in inter- RIGHTS national programs. RCM analysis showed that the universi- avoid the com- ty provided a $3M “subsidy” to international programs and Without properly-de- plexity of fully allowed university leadership to make strategic decisions signed decision rights around investments in international programs. and thoughtfully-devel- adopting it? oped overhead alloca- If moving to an RCM model isn’t $10.9 M tion equations, individ- the right path for your university, ual units may operate Overhead $1.5 M you can still achieve transpar- counter to the best in- Comp/Benefit ency by conducting a deep-dive $7.2 M terests of the university $2.5 M financial analysis, which is usually as a whole. For example, the first step for implementing an with budget autonomy RCM model. The financial anal- under an RCM model, Programs ysis disentangles the complex $6.9 M the Law School may budgetary decisions made over grow frustrated with HR the years to provide transparency service levels and devel- into the financials of each unit. op its own HR function Revenues Expenses In essence, the financial analy- internally rather than sis simulates adopting an RCM pay for use of the central HR function. Law model by allocating the revenues School service levels improve, but the Law School’s decision and costs, both direct and university overhead, to the unit increases the overall cost of HR for the university. that generated them – essentially creating a P&L statement for each university unit. THE VALUE OF CROSS-SUBSI- Determining which unit generated each tuition or gift dollar DIES and each IT or procurement expense can be somewhat RCM introduces a “profit” motive and mentally into uni- complicated, and potentially controversial, but provides versity budgeting, but universities are not for-profit cor- greater transparency into the financial health and incentives porations. Smaller-scale, less-popular programs, such as of units throughout campus. For instance, your residence Philosophy or Art History, may never be able to appear life program that might appear profitable in your current profitable, but they are critical parts of the university’s social budget, but the program could be costing you more than you and educational mission. Under traditional budgeting, these realize due to obscured cleaning and maintenance expenses programs are “subsidized” by larger-scale departments, such incurred by the central facilities functions. OUTSOURCING DECISION The RCM analysis can be conducted regularly (e.g. annually) For functions that are not core to the university’s mission and provide one input into the central budgeting process. (e.g., bookstore, dining, facilities, etc.), the financial analysis By conducting this RCM financial analysis, these and other can provide insight into the total cost of the function. This types of financial implications will become transparent, can be used as an input into outsourcing decisions to help arming you with the information you need to make strategic universities compare the costs of outside providers versus decisions. keeping the service in-house.

This sounds great, but what kind BUDGET PROCESS MODIFICA- of decisions do universities typi- TION cally make with this analysis? Perhaps most straight-forward, the analysis can inform changes to the current budgeting process. For example, in- After understanding the termittent re-baselining current true financials of each budgets, adjusting overhead fees university unit, there “We were able to do so much with charged to units or developing are a number of differ- the budget analysis. Our Board had a strategic fund that can be ent strategic decisions been pressuring our academic leadership to con- centrally allocated, on an annual universities can make, basis, for strategic projects. for example: solidate programs, and we were able to demon- strate that consolidation didn’t make sense – each As universities continue to PROGRAM program had a positive contribution margin. We face increasing financial pres- OFFERING were also able to justify differential tuition for sure to cut costs and evaluate REVIEW our Nursing and Visual Arts programs and realign all elements of your operations, some of our budget toward our strategic priori- financial transparency is becom- Using the RCM finan- ties. The budget analysis was an extremely pow- ing increasingly critical. Regard- cial analysis as an input, erful tool.” less of whether you ultimately leadership can make decide to pursue an RCM budget informed discussions model, completing an RCM-style about their academic - University Senior Vice President and CFO financial analysis can uncover a program offerings. wealth of knowledge and insight They can decide which into your university’s or your programs should be ex- unit’s financials. This can be used to inform a variety of panded (e.g., because they are highly profitable and well-per- strategic decisions that can better set your university up for forming) and which ones should be considered for elimina- future success. tion or downsizing due to financial and other performance issues.

TUITION ADJUSTMENT JUSTIFI- CATION The financial analysis can also be used to justify tuition or fee adjustments. For example, it can identify costly programs that are good candidates for differential tuition or additional course fees, as well as student programs that may require increased or decreased student fees to cover changes in offerings. For more information, contact Jonathan Selter at jselter@ censeoconsulting.com.