Budget bottom line: decline

March 19, 2004

Full economic costing will harm research outside the elite circle - to the country's cost, says David Gillingham.

In the week that Gordon Brown outlines his budget and offers the carrot of extra money for science, it is appropriate to look at how management concepts such as full economic costing (FEC), which were abandoned by industry 30 years ago, might work to squeeze the research budgets of universities outside the favoured Russell Group to the detriment of UK research as a whole.

Arguably FEC, or standardised costs as it was known in the 1970s, was partially responsible for the decline of British manufacturing. Will it now bring about the decline of UK higher education?

FEC involves allocating all costs against any particular activity, be it teaching, research or third stream. These costs will consist of two major groups: variable costs, such as staff pay, which vary directly in relation to the volume of activity, and fixed costs or overheads, which are allocated against activities by an arbitrary method such as calculating them as a percentage of staff costs.

Universities are now required to calculate FEC for all activities. When they price activities at less than FEC, they will need to show where they obtain the funding to provide this subsidy. In particular, we will be required to show that we do not use funding council money for teaching to subsidise research and other activities.

Many universities do research funded by charities that do not provide for overhead charges. All such work is, by definition, therefore at less than FEC. Unless we can show that we have other funds to cover the subsidy involved in this work, we will have to stop doing it. We also might take on contract research for a company in which we cover, say, only 50 per cent of our overheads. Using the logic of FEC, we would not take on such work unless we could negotiate a price higher than the FEC.

If institutions systematically turn down such work, they will have less money to contribute to overheads, and the overhead allocation on teaching and research will rise. This is what happened to British industry in the 1960s and 1970s: as price competition increased, companies quit taking orders for products whose prices were below the FEC. As a result, they had to increase the overhead charge on remaining products and further price them out of the market. Perhaps we are beginning to see this in higher education as the Confederation of British Industry reports that some large companies are considering moving their contracts for university research offshore.

So let's return to basics. Any activity that generates more than variable costs makes a "contribution" to fixed costs. It is not a case of teaching subsidising research costs, because without these activities we will need more funding to make up for that lost contribution. Anyway, all costs are to some extent arbitrary. When one accountancy expert was asked what an item cost, he replied: "How much do you want it to cost?"

Any system of allocating fixed costs is dangerous. It is for the management of any university to determine whether it is in its particular interest to take on any given contract. The requirement to use full economic costing is another example of interference with the autonomous decision-making powers of universities.

A few institutions will benefit from the application of FEC to research. As the government will not be able to fund the increase in research funding to cover the full economic costs, the result will be fewer contracts at a higher price. These contracts will inevitably be awarded to the larger research institutions. These institutions will also have other income streams to show that they can afford to "subsidise" their work with charities. This will add yet another push to the ever-increasing concentration of research.

David Gillingham is pro vice-chancellor of Coventry University.

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