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Are the IIMs profiteering?

By Uday Damodaran
April 06, 2004 12:12 IST
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(This is a sequel to the article by this author [April 1] that looked at the issue from the perspective of the student. This article tries to complete the discussion by looking at the proposed fee cut from the perspective of the management institute. Without looking at the contentious issue of computing the exact costs incurred, per student, by an IIM, the article looks at the impact of a fee cut on an IIM and at the larger issue of pricing the IIM MBA.)

The fee suggested by the government per student is Rs 30,000 per year for the two years. At an institute like IIM, Kozhikode, the fees being charged currently are approximately Rs 1,00,000 per student per year.

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On the 2003-04 base of 180 students, this would lead to a revenue (top-line) loss, per annum, of Rs 70,000 x 180 = Rs 1.26 crore (Rs 12.6 million) for the institute. The total internal income generation (including revenues from sources other than student fees) for IIM-K for the year 2002-03 was Rs 2.75 crore (Rs 27.5 million). Assuming this figure for 2003-04 to be Rs 3.5 crore (Rs 35 million), this translates into a 36 per cent (1.26/3.5) loss in revenue for the institute.

The revenue deficit (total income minus revenue expenditure, or the bottom-line) for IIM-K for the year 2002-03 was Rs 0.54 crore. Since the fee reduction will not automatically lead to a reduction in costs, the effective impact of the fee reduction on the revenue deficit (bottom-line) of an institute like IIM-K would be a whopping 233 per cent (1.26/0.54), assuming the deficit to remain unchanged for 2003-04.

As argued in the earlier article, faced with a fee cut, management institutes might withdraw from certain activities in which it currently plays the role of a facilitator. The costs thus transferred from the institute to the students, in an institute like IIM-K, will be about Rs 20,000 per year per student.

On a base of 180 students this would lead to a 'cost saving' of Rs 20,000 x 180 = Rs 0.36 crore. If an institute like IIM-K were to do this, the impact on the revenue surplus (bottom-line) would be cushioned to some extent but would still be 167 per cent ([1.26 -0.36]/0.54). The percentage drop in revenue (top-line) would, of course, continue to be 36 per cent (1.26/3.5)

So a fee cut would severely impair the surplus earning capacity of the IIMs. But are the IIMs, in the first place, justified in charging their students the fees that are currently being charged? Is the current level of fees 'fair'? In the language of markets, what we are really asking is: how has the price of this good -- the IIM MBA -- been arrived at? And is the price 'fair' to the consumer, the student?

We can look at the issue from two angles. One, from the point of view of value to the consumer -- the student -- and two, from the point of view of costs to the producer -- the institute.

A few weeks back I was on the selection panel for recruitment to an accountant's post for IIM-K. Most candidates to the post recognised the fact that the IIMs are not-for-profit organisations but were unable to arrive at a parsimonious description of a not-for-profit organisation.

Does it mean that a not-for-profit organisation should always run up losses? Does it mean that they should be involved in charity? We could not afford to be harsh on the candidates for their lack of clarity on this issue -- because the lack of clarity on this issue is widespread.

In my earlier article I had estimated the value to the student ('the consumer') of an MBA from an institute like IIM-K ('the good') to be well over a crore of rupees. This figure represented the difference between the present values of the future earnings streams for the student with an MBA and without an MBA.

A profit seeking, profit-driven institute ('the producer') -- especially if the competition is weak -- would factor this estimate of value into its fixation of fees ('the pricing'). It would try and extract the maximum price for its product while still leaving enough residual value-for-money to the consumer to entice him/her to buy the product.

Juxtapose this against reality. The total fees (over the two years) at an institute like IIM-K is Rs 210,000, as compared to an estimated value of its MBA of more than a crore of rupees! Even without getting into figures, in general it is fairly widely accepted that while an MBA from an IIM is of far greater value than an MBA from other institutes in the country, the fees charged by IIMs are lower than, or comparable to, the fees charged by other institutes.

In other words, whatever the driving forces (government support, etc) the IIMs can definitely not be accused of being avaricious producers of their MBA. As it should justifiably be, the consumer-student retains a huge chunk of the value (for all practical purposes, the entire value) created by the IIMs: the consumers' surplus far exceeds the producers' surplus.

Having examined the issue of 'fairness' of the levels of fees being charged by the IIMs from the point of view of value to the consumer, let us now examine it from the point of view of costs to the producer -- the institute.

For an institute like IIM-K, which charges approximately Rs 100,000 per student per annum as fees, at least Rs 30,000 per annum per student (co-incidentally, the suggested fees!) can be traced to direct costs like providing text books for each course, funding extra-curricular and co-curricular activities of students, utility costs, etc.

These costs do not include the major costs associated with offering an MBA programme: faculty time, wages and salaries for supporting staff, library related expenses. So while this article does not attempt to cost the MBA offered by IIMs, it is inconceivable that the IIMs are charging fees that are in excess of their costs of running the MBA programme.

While publicly funded institutes like the IIMs should not -- and do not -- seek to profit from their pre-eminent status, it is equally important that they generate enough surpluses to ensure their long-term survivability. At the current level of fees they might only be just about doing that.

What does all this mean?

From the earlier article of April 1 we concluded that:

  • The proposed fee cut would have very little impact on the real costs incurred by a student.
  • Any adverse impact on the value creation capacity of the IIMs would harm a student, destroying the monetary value of an IIM MBA by tens of lakhs of rupees.

From today's article we conclude that:

  • The proposed fee cut could hurt the IIMs, the impact being about 36 per cent at the revenue level and 167 per cent - 233 per cent at the surplus level for an institute like IIM-K.
  • The IIMs fee structure seems 'fair': definitely from the point of view of value left in the hands of the student and most probably from the point of view of recovery of costs.

Pray, then, why should we go through an exercise that does not benefit the student but hurts the institute? Even if the government were to make up the shortfall in revenues, why go through an exercise that does not benefit the student, given that the stated motive of the move is to benefit the students from economically weak backgrounds?

The whole fee cut issue therefore leaves most people confused; it leaves people associated with the IIMs very confused...and sad. Maybe there is some logic, that is not immediately apparent, in the government's move; or maybe there have been some gaps in communication.

What makes the IIMs unique is the foresight of the government. Unlike the stand-alone Harvards and Stanfords, the government created a network of institutes.

The beauty of the IIM system is that it has always been a fraternity with, if I may borrow from Amitav Ghosh in The Glass Palace, 'invisible bonds linking people to one another through personifications of their commonality'. Sadly, even this source of strength is in danger of being destroyed by the divisions that are being caused by an issue that was not, in the first place, the creation of the IIMs.

The author is a member of the finance faculty at IIM, Kozhikode.

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