Friday, 18 September 2015

Why is a university like a night club?

New York Times magazine last week had an excellent report by Adam Davidson on college tuition in the U.S. There is lots of good parts to it (I recommend reading it all), but I want to focus on a few bits in particular, starting with this:
But probably the single most important factor behind the rise in tuition is one that few other businesses share: Students are not just customers; they are also an integral part of the core product. When considering a school, potential students and their parents often look first at the characteristics of past classes: test scores, grade-point averages, post-college earnings, as well as ethnic and gender mixes. School admissions officers call the process through which they put together their classes the ‘‘shaping’’ of the student body. Kevin Crockett is a consultant with Ruffalo Noel Levitz, a firm that helps colleges and universities set prices. He says that the higher the prices that schools charge, the more options they have in recruiting exactly the students they want.
"I’ve got to have enough room under the top-line sticker price," he says. A school that charges $50,000 is able to offer a huge range of inducements to different sorts of students: some could pay $10,000, others $30,000 or $40,000. And a handful can pay the full price.
What's going on here? This is a not-so-subtle form of price discrimination  - where different consumers (or groups of consumers) are charged different prices for the same good or service, and where the difference in price does not arise because of a difference in cost (and which I've previously written on here and here). Typically in price discrimination, the firm charges a higher price to groups of consumers that are willing to pay more for the good or service. However, for universities it isn't that simple because the make-up of the student body is going to affect the willingness-to-pay of each student. So, universities face a difficult optimisation problem.

How does that make them like night clubs? Davidson explains:
There’s a provocative analogy to be made with how another industry does its pricing. I called Paul Norman, who owns a company that promotes high-end dance clubs in London, and he agrees that his clubs have much the same challenge as colleges and universities. Their appeal to new customers is based, in large part, on the mix of customers who are already there. The biggest spenders are wealthy men from Russia and the Middle East. But they won’t spend a lot of money in a club filled with people just like themselves. Women who have the right look — posh in Chelsea, a bit more flash in Mayfair — are admitted free and are offered free drinks, but only if they arrive early in the evening and happily mingle and dance. He said that clubs do their own version of enrollment shaping. "It’s good for the crowds if you have a mix of ethnicities," Norman told me. On any given night, he said, about a quarter of the clubs’ guests get in free. It’s an odd model: giving your most valuable product away to some and charging a lot to others. But, Norman said, if everybody paid the same price, nobody would want to come, and in a few weeks clubs wouldn’t be able to charge anyone anything.
Similarly, if an elite school like Harvard or Princeton insisted on admitting only students willing to pay the full freight, they would soon find they weren’t so elite. Many of the best teachers would rather go elsewhere than stay in a gated, rich community. The most accomplished rich kids could be lured away to other schools by the prospect of studying with the best students and teachers. So, a school with the same high sticker price for everyone would be unlikely to have the attributes — high test scores, Nobel Prize-winning faculty, a lively culture — that draw national or international attention.
So coming back to price discrimination, in order for this pricing strategy to be effective, there must be different groups with different willingness-to-pay for the good or service, the firm must be able to determine which consumers belong to which group, and there must be no transfers between the sub-markets. The first condition is met (students from higher income families are willing to pay more for elite education), and the third as well (you can't on-sell your education to someone else). The second condition is met by the increasing use of data on prospective students:
The pricing of college and university tuition used to be based on gut feelings, Crockett told me. Until around 1992, administrators would glance at what their peers were charging and come up with a number. Today, the process involves a level of mathematical and statistical rigor that few other industries could match. Crockett uses a team of statisticians and data analysts, the latest in software and data with hundreds of variables on students’ ability and willingness to pay, academic accomplishments, most likely choices of majors, ethnicity and gender, and other attributes. To the public, one number is released: the cost of tuition. But internally the school likely has dozens of price points, each set for a different group of potential students. The tools can determine how valuable a potential student is to the school’s overall reputation: more points for sports and scholarly accomplishment, fewer for the telltale signs of a likely dropout.
So, universities in the U.S. use your data to determine fairly closely how much you are willing to pay and can price accordingly. In other words, they are dynamic pricing like many other firms, but recognising that they want to encourage some particular students to join their student body and will offer them lower prices even if the student would be willing to pay more. Because every student pays a different (personal) price, we refer to this as personalised pricing (or first-degree price discrimination).

In case you're wondering, New Zealand universities can't follow suit, at least not completely. Apparently we aren't allowed to attract students with discounted fees, although we can offer scholarships or even discounted transport. However, this isn't exactly the same as providing partial fee concessions, since it is more difficult to target scholarships to those with lower willingness-to-pay.

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