Change or perish, institutions told

University surpluses could be wiped out by 2012, leaving institutions facing financial ruin unless they make radical changes to the way they work, an analysis by accountancy firm Grant Thornton states.

It suggests that longstanding financial problems, such as the pensions deficit, have been compounded by the recession, leaving universities little option but to act now to secure their futures.

The frank assessment for Times Higher Education has highlighted a series of financial hurdles that universities must clear. They include:

• cuts to government funding
• the growing burden of debt repayments
• pension and pay commitments
• a potential drop in international and domestic student numbers (see boxes below).

The analysis shows that before the recession, university surpluses grew year on year; but as financial pressures increase, a "typical" institution's surplus is set to drop from £5 million this year to zero by 2012.

"We're now in an environment where a lot of the good news of the past has either stopped or turned into bad news," said David Edwards, director of Grant Thornton's education group. "The days when institutions could bury their heads in the sand and not worry too much have gone."

According to the analysis, some university finance directors may not comprehend the scale of the problems, while some vice-chancellors who are nearing retirement are aware that the issues will not be resolved on their watch and are failing to act as a result.

Mr Edwards said he was worried that some universities do not have the management structures to cope with the financial storm on the horizon.

"The way that some have behaved in the past is to say: 'Don't worry, the Higher Education Funding Council for England will bail us out,' he said.

"This is not going to happen any more."

Now for the good news

Despite the gravity of the warnings, there is some good news in the analysis. Universities entered the recession in "better shape than ever" thanks to their surpluses, and the firm perceives a "liberalisation" in the tuition-fees debate that suggests that they are likely to be raised.

It also proposes solutions for the problems facing the sector, although not all of them are likely to find favour among academics.

David Barnes, lead partner of the education group, said universities must become more businesslike to weather the storm.

"They need to put the business model first. Everything else follows from that, including academic research and teaching," he said.

"There are a number of universities where the academics are still in charge. They are being led by people who put the academic focus first."

He and Mr Edwards suggested that governing bodies should be overhauled to enable universities to take rapid financial action.

"Universities tend to be quite cumbersome organisations. You now have issues that need to be dealt with immediately," Mr Barnes said.

He agreed with the suggestion made by the Policy Exchange think-tank earlier this year that failing universities should be allowed to go under in some circumstances.

Mr Edwards added that planning was vital to surviving the recession: "If you're working on the principle that it's going to be OK because nobody has ever failed, there is going to be a serious problem."

Karel Thomas, executive officer of the British Universities Finance Directors' Group, said the analysis was simplistic and relied on the assumption of ceteris paribus - all else being equal. "Unlike a theoretical model, other variables will not remain unchanged," she said. "To say that surpluses could be wiped out by 2012 is a sweeping assertion. Without examining the detail, it is potentially dangerous.

"There may be the behaviour described, but I do not believe it is endemic. Business methods have a lot to commend them, but teaching and research are the business of a university. Finance directors know they should not forget that."

hannah.fearn@tsleducation.com

BLEAK PICTURE UNDERESTIMATES DEPTH OF CRISIS, SAYS V-C

One vice-chancellor said Grant Thornton's analysis of the financial problems facing universities was a conservative estimate of the recession's impact.

Speaking on the condition of anonymity, he said: "The general view is that there may be 30 institutions facing a deficit this year. I think that is a significant underestimation."

Pointing out that institutional finances were based on the growth they have experienced for a decade, he said the impact of the sharp downturn had been severe.

He added that pay and pension commitments would put universities under huge strain.

"Employer contributions (to pensions) are going up, and last autumn we were hit with a 5 per cent pay rise that no one had built into their budgets," he said.

He predicted that universities would be allowed to go bust in the future.

"There is no way the UK can afford the current configuration," he said. "We have got to find more effective ways of delivering education."

THE PROBLEMS: INCOME IS CRASHING AS BILLS CLIMB...

As the Government fights to save money, public funding for teaching from the funding council has already been slashed and further cuts are inevitable.

Universities that rely on investments have faced a major drop in endowment income, and businesses can no longer afford to work closely with universities.

In addition, the tough investment market means that lucrative spin-off companies set up by graduates or academics are unlikely to flourish, leading to another cut in income.

Meanwhile, expenditure is rocketing and universities are struggling to meet their financial commitments to staff.

In 2006, the University and College Union agreed a three-year pay deal of 13.1 per cent, with a final-year injection of 2.5 per cent or the retail prices index figure, whichever was higher.

Last year, RPI stood at 5 per cent, so that was the figure paid. It is now -1.6 per cent. Negotiations for the 2009-10 pay deal are under way.

The analysis states that some institutions may have relied on individual schools or departments to make efficiency savings to meet pay commitments, but with the current funding cuts, this is unlikely to work.

The sector is also struggling to meet its burgeoning pension commitments.

"Pension liabilities are the elephant in the room. It's such a huge issue that it's something universities are ignoring, saying the Government will have to deal with it. I can't see that happening," said David Edwards, director of Grant Thornton's education group.

THE INTERNATIONAL LIFELINE IS UNDER THREAT...

International and domestic threats mean that universities can no longer rely on growing income from the overseas market.

"Overseas recruitment has become accepted as core funding. It is now inbuilt in the way universities fund themselves," said David Edwards, director of Grant Thornton's education group.

Competition is also growing from within international students' home countries. China sends more students to the UK than any other country, but right now an average of one new Chinese university opens each week.

These problems are compounded by increasingly strict visa regulations for visiting students, plus fears about swine flu.

At home, prospective students may become reluctant to take on student debt to complete a degree, fearing that they will be unable to pay it off.

Demographic change will also leave universities in regions with a shrinking population, such as Cumbria and Northamptonshire, with concerns about student recruitment.

AND SERVICING DEBT IS COSTLY

When times were good, universities regularly borrowed to fund capital projects such as campus refurbishments.

They borrowed on the basis of predicted future income from government funding and student tuition fees, both of which are now at risk.

Many new buildings, such as libraries, do not generate additional income, the Grant Thornton analysis warns. David Barnes, lead partner of the firm's education group, said that unless an institution is attracting more students as a result of new facilities, it must fund them from its existing income.

Universities are unlikely to plug this gap by recruiting more students because of the cap imposed on additional places, he added.

Universities' liquidity is also drying up, and taking on additional debt is more expensive. In addition, utility costs are spiralling, leading some institutions to look for innovative solutions to reduce their bills.

One option is to make savings through more efficient buildings, Mr Barnes said.