Duncan Murphy sets out a new approach to understanding fee pricing in independent schools

 

Many significant factors, such as the Covid pandemic and the cost of living crisis have already prompted independent school senior management and governors up and down the country to focus on plans for futureproofing their schools. But now the sector faces further unprecedented challenges. If not already, a key agenda item for all board meetings this term should be a robust discussion about how to mitigate one or more of the obvious financial threats to independent schools, especially the much-mooted addition of 20% VAT on fees, which seems an inevitable consequence of a Labour government being elected. How far can schools simply pass on this extra burden to parents, and still justify the further fee increases required to balance the books elsewhere?

It is evident that larger schools, or those that are a part of a bigger group, may be more fiscally sustainable than smaller, stand-alone schools. Nonetheless, irrespective of where their school sits in the pecking order, it is vital that leaders carry out appropriate due diligence to better understand the dynamics that, to put it in the languages of economists, a spike in costs may inflict upon their current, and potential, customer base.

It’s worth noting that the full impact of most current threats is unlikely to be felt for three to five years. This is because most families with children already progressing through the independent school system will do their utmost to retain continuity of education for their child, while new joiners will think twice before committing to that journey, and probably delay the starting point for their child as long as possible, unless there is a particular reason to move quicker, such as for wellbeing or academic reasons. However, discussion and planning needs to start immediately.

Threats

In no particular order, the following threats should be high on the risk register of all well managed and governed educational institutions. Some are ones affecting all parts of society, while others are more specific to the independent schools sector.

First, and perhaps most obviously, is the fragile state of the economy. A well-publicised cost of living crisis driven by rampant inflation, coupled with soaring energy costs, has hit families hard. Additionally, interest rate rises have affected homeowners across the age and income range, especially for many families about to come off fixed rate deals, who will be panicked by the difference in their monthly outgoings, despite the likelihood that interest rates may now have peaked and better deals may soon be available.

Compounded by the ongoing uncertainty of Brexit and the legacy of Covid, there are lots of political and economic questions that remain unanswered. A direct consequence of this is that fewer families are committing to the expense of a private education for their child until there’s greater clarity for the longer term.

Whatever your political persuasion, it’s hard to argue against the increasing likelihood of a Labour government. Its most recent manifesto and other pronouncements have seen them once again kicking around the private school political football. While, veiled or otherwise, immediate threats to strip schools of their cherished charitable status seem to have receded, research published by the Independent Schools Council (ISC) estimates that approximately a quarter of independent schools could shut their doors as a result of policies proposed by Labour being enacted.

More specifically, there’s a very real prospect of VAT on fees being introduced in the medium term, and possibly being announced in the first budget of a new government, as an easy promise to keep. As the Independent Schools’ Bursars Association and ISC have regularly warned in their conferences and mailings, the political arguments surrounding independent education are ideological and consequently all counter-arguments, no matter how logical or grounded in data, are less likely to be effective in overturning such a policy. And the debate on charitable status will not simply go away, even if Labour has pulled back on it for now. It could well be reopened once it feels comfortable in power, especially if it has a sizeable majority.

There’s the rising cost of remaining in the Teachers’ Pension Scheme to consider. The financial reality could make doing so prohibitive for all but the minority of independent schools, although there’s considerable potential for disruption to staff morale (and thereby a knock-on effect to parents) if the consultation process for withdrawal from the scheme is not conducted in a professional, sensitive and timely manner.

Looking at demographics, the current low birth rate will affect intake into reception, and recruitment into younger year groups, until 2032. Put simply, there will be significantly fewer children to go round in what is already a marketplace with plenty of providers. And in state schools, this means that the perception of larger class sizes might not be as powerful an argument for parents who are weighing up a move into private schooling.

Finally, the diversification of independent schools’ business models is a major contemporary trend. Things such as the expansion of provision at the lower or upper end of the age range, revision of admissions policy to reflect a growing SEND market, international franchising, moving from single-sex to co-education, and the M&A market are all incredibly buoyant. While these are positive developments, it does open up the potential for schools within close proximity of one another to step on each other’s toes.

A new approach

We would argue that the time is ripe for a complete shift in independent schools’ thinking, and a move towards embracing modern practices of price management. At present, their thinking might be better described as approach-avoidance – heads in the sand. While independent schools are existentially dependent on fee revenues, any increase is communicated to parents with the tone of apology. This discomfort when facing the reality of price-setting has left the sector far more vulnerable to shocks such as an incoming Labour government than it need be.

A specific fee elasticity report compiled by MTM offers a general overview of how schools across the UK may fare in the face of the threats outlined above, together with a bespoke analysis of data for each school set against the socioeconomic profile of its historic and current catchment areas, projected birth rates and number of competitors.

Using a sliding scale, each school’s senior management and governors can review a number of possible options for sustainable fee increases, backed by qualitative and quantitative data, in order to reach an informed understanding of the options available to them. We believe the security that evidenced fee elasticity research can provide for independent schools is an important component of business development for the sector at such a time of economic and political volatility – and can be used as a key plank in building a strategy based around behavioural price management.

Current pricing practice

Current pricing practices in the UK independent school sector was summarised by Independent Schools Plus as follows: “Historically, when setting their budgets schools calculate their costs… and then balance their budget by… increas[ing] their fees; but now this is so much more difficult. Schools have got to keep their fees as low as they possibly can as parents, facing many of the same pressures, can’t afford a material increase.”

This approach amounts to what academics and practitioners refer to as a ‘cost-plus’ pricing method. Prices are set so as to cover the costs of product or service delivery and the profit margin the provider wishes to make per unit sold. In a not-for-profit context, the aim is not to generate profits per se, but to create a surplus that can be put into reserves or reinvested into activities in support of the organisation’s mission. Consumer behaviour only enters the process as an afterthought at best – be wary of setting too high a price that drives customers away.

While academics and practitioners of price management acknowledge the importance of cost analysis in a pricing process, they are quick to point out that cost analysis alone will not lead an organisation to sustained success: Hermann Simon and Martin Fassnacht have stated: “Products are [often] conceived, developed, and then priced on a cost-plus basis… As a consequence… some products are developed but… flop when they are launched. Ideally, companies should flip this flow around… The question ‘what should the product we just developed cost?’ [should be] replaced by the question ‘how much should the project we plan to develop cost?’ based on what buyers are willing to pay for it.”

For independent schools, whose revenues are almost entirely driven by fees, understanding what drives parents’ willingness-to-pay is a tremendous competitive and strategic advantage. But this can only happen if senior management and governors stop simply accepting the idea that parents can’t or won’t stomach fee increases as an article of faith. The degree to which fee increases will affect enrolment is an empirical question, and one that has been answered by market and economic analysts in a variety of different contexts – including the UK independent education sector – for some time now.

Price elasticity of demand

The price elasticity of demand (PED) measures the sensitivity of demand to price changes. The least-inelastic items are those that are very hard to do without (electricity, petrol, housing) or are considered a staple item (eggs). By contrast, the most-elastic items generally consist of entertainment, leisure and travel experiences – things that people tend to consume less frequently.

Using proprietary data on school fees and administrative data on school enrolment and quality, we employ dynamic panel methods to estimate the price elasticity of schooling. Our estimates suggest that a 10% change in fees results in a 4.4% reduction in enrolment, all else held constant, and a 15% change a 6.6% reduction, which equates to 36,580 pupils.

While this 15% increase in fees would see turnover appearing to rise by 8.37%, given that the fee increase is a direct tax, the revenue therefore generated for the school is calculated as follows, resulting in a decrease of 6.6%.

The range of estimates of PED for private school run from –0.19 to –0.49. This means that demand for private schooling is as elastic as demand for beer and may be as inelastic as demand for electricity, roughly speaking. While it may be that keeping fees low is a reasonable course of action for some independent schools, the empirical evidence suggests that this may be one option among many.

Demand elasticities of product characteristics

While we cannot provide an extended discussion on this point for the sake of brevity, we will point out that there are often other demand-relevant characteristics for which one may wish to obtain a demand elasticity estimate (for example, quality).

Here, we measure the percentage change in demand in response to a 1% change in the characteristic Z. In the education setting, an important characteristic could be teacher-pupil ratios. Understanding the degree to which the market values smaller class sizes (as embodied in the class size elasticity of demand) can provide guidance for independent school leadership looking to understand how best to improve market position.

Towards behavioural price management

First you need to brief and receive approval from your board. This request should outline the necessity and potential benefits of revising the current pricing approach, while emphasising that this initial phase is about gathering information and options, not committing to specific changes.

Then identify the strengths and weaknesses of your school. How do they compare and differ to those of your competitors? From this exercise, try to identify the most important dimensions of competition (price, test scores, teacher-pupil ratios, etc).

Research your target audience. From your assessment of market position, you should be able to define the segment of the market you best serve. Do you know what these parents are looking for? And what they value most?

Next, draft a positioning statement. This is a strategic tool that guides marketing and operational decisions, ensuring that all aspects of the school align with how it wants to be perceived by its target audience. It identifies your niche in the market and highlights what makes your school uniquely suited to serve it. The more clearly you identify the things that make you stand out, which parents value, the more effectively you can make necessary changes.

Analysis and strategic review

The next stage involves conducting a strategic review of school operations. You must assess whether anything identified above requires any changes to how you operate. For instance, you may realise that enrolment has been hampered by poor academic achievement relative to competitors. As such, you would need to review educational resources (both teaching and technology). On the other hand, you may discover that what was once a highly-touted feature of your school – a flagship programme or activity – is not as valued as you thought, so you may decide to discontinue it.

You should also conduct a strategic review of your school fee structure. Analyse the fee schedule for different age groups to ensure that it aligns with your demand analysis. And review the school’s bursary policy.

Implementation

Finally, you need to implement a strategic price communications plan. You must develop a clear narrative that explains to parents why you charge the fees you do. In such communications, it’s generally advisable to avoid apologetic or defensive language. Instead, aim to be clear, transparent and confident, while still being empathetic and understanding of any concerns parents might have.

A bad example is something along the lines of: “We have tried to keep fee increases as low as we can, but the new Labour policy on VAT has forced our hand. We will try to help as many families as we can, but please understand that bursaries are limited.”

Instead: “In response to the recent changes in VAT policy, we have adjusted our fee structure to ensure that we continue to provide the highest standard of education. We understand that any fee increase can be a concern. As such, our bursar’s office is always available to discuss bursary options and requests for financial assistance etc.” is so much better.

 

Duncan Murphy is the director of education for MTM Consulting.