A lot of media space has been taken up discussing the issue of fees to be charged by the Indian Institutes of Management. Much of the discussion has been narrowly focussed on the level of fees at IIMs, its affordability, and its justification.
Let us focus instead on the real impact of reduced fees on students, impact not just in costs but also benefits. And not only at the immediately apparent costs, but also at the 'hidden' but real costs to a student.
The fees suggested by the government per student are Rs 30,000 per year for two years, totalling Rs 60,000. At an institute like IIM-Kozhikode, the fee charged currently is approximately Rs 100,000 per student per year. Therefore the suggested fees lead to a headline-grabbing 70 per cent reduction.
Post-graduate programmes at the IIMs are residential programmes. Mess charges (excluding hostel room rents) would be about Rs 2,000 per month.
Considering the typical 18 months of residence, this translates into expenditure of Rs 36,000 over two years. Local travel, travel to and from homes, stationery costs, et cetera would be about Rs 500 per month, or Rs 9,000 over two years.
This means that the actual cost to the students is not just the fees of Rs 100,000 per year but also these other costs of Rs 22,500 per year. Therefore the headline-grabbing 70 per cent reduction in fees is now a more modest 70/000/122/500 = 57 per cent reduction in costs.
Every student of management is taught the concept of opportunity costs. Well before a student steps into a management institute, s/he uses the concept while deciding on which institute to join or whether at all to embark on a management education.
Many students come to the IIMs with prior work experience. At an institute like IIM-K, the proportion of students with work experience would be 50 per cent or more. Among students with work experience, the average work experience would be 12 months.
Many of these students have undergraduate engineering degrees from reputed colleges/institutes. The average salary drawn by a student who joins an institute like IIM-K with prior work experience is Rs 2.5 lakh (Rs 250,000) per year.
For such a student, the costs are no longer fees and mess charges alone. Spending two years in gaining a management education would entail foregoing Rs 2.5 x 2 = Rs 5 lakh of income. This is his/her 'opportunity cost'.
What would the opportunity cost be for a student without prior work experience? Definitely not zero! Most of these students, too, are capable of finding themselves decent employment.
Though more difficult to estimate, the earnings capacity of a student who joins without prior work experience would be about Rs 1.8 lakh per annum, translating into an 'opportunity cost' of Rs 3.6 lakh over two years.
Taking the proportion of students with work experience to be 50 per cent, the average opportunity costs for a student joining an institute like IIM-K would be (0.5 x 2.5) + (0.5 x 1.8)= Rs 2.15 lakh per year, or Rs 4.3 lakh over two years.
Taking into account both opportunity costs and costs other than fees, the -headline-grabbing- 70 per cent reduction in fees is now a mere 70,000/(215,000+122,500) = 20.75 per cent reduction in real costs. It has to be understood that in the case of higher education, opportunity costs are very important.
For example, an IIT graduate from an economically weak background, with a campus placement offer of Rs 3 lakh per annum, and also an admission offer from an IIM, will not be basing his/her decision on whether the fees at the IIM are Rs 100,000 or Rs 30,000. S/he would be more worried about the loss of Rs 6 lakh that s/he could have earned (and thus eased the family's financial burden) if the offer from the IIM is accepted.
Faced with a fee cut, management institutes might withdraw from certain activities. For example, currently, IIM-K buys textbooks and distributes them free to students.
While this arrangement increases efficiencies, the institute can revert to the situation that prevailed when I was a student at IIM-Bangalore -- it can ask students to buy the recommended books directly.
Similarly, the institute currently administers budgets for various co-curricular and extra-curricular student activities. Here too, it can ask the students to fund and manage these activities on their own. These costs will then be borne directly by students. In an institute like IIM-K, this will be about Rs 20,000 per year.
Where does this leave the student? Taking into account opportunity costs, costs other than fees and costs transferred from the institute to the student, the headline-grabbing 70 per cent reduction in fees is now a mere (70,000-20,000)/(215,000+122,500) = 14.8 per cent reduction in real costs.
Then, the question often posed to me is why students are protesting the proposed fee cut.
The answer is obvious. A student is like any other consumer. S/he is paying for the service provided by a management educator. And like any other consumer, a student is looking to get 'value for money,' not just a reduction in costs.
How would you value a management degree from an institute like IIM-K? Assume the working life of a student to be 35 years. The present value of the future earnings of an average student after s/he completes management education may be calculated as: PV of future earnings (6/0.13 - 0.10) Rs 200 lakh
(Explanation: After completing studies from an institute like IIMK, students are assumed to start at an average salary of Rs 6 lakh per annum. 13 per cent is the discount rate, taken to represent the risk associated with the future earnings stream. 10 per cent per annum is assumed to be the salary growth rate of a student with a management degree, based on salary surveys.)
However, even without a management degree, a student has the capability of generating an earnings stream stretching into the future. The present value of the future earnings of an average student without a management degree may be calculated as: (2.5/0.13 - 0.08) Rs 50 lakh.
(Explanation: Students who get into an institute like IIMK are assumed to be of a calibre such that after two years they are capable of earning Rs 2.5 lakh per year. 13 per cent is the discount rate taken to represent the risk associated with the earnings stream. 8 per cent per annum is assumed to be the salary growth rate of a student who carries on in his/her career without a management degree, based on salary survey)
The gross value addition due to the management education for an average student is thus: Rs 200 lakh - Rs 50 lakh = Rs 150 lakh.
This estimate of value added is far in excess of the cost of the management education. But this still does not answer the question: why are students protesting against the proposed fee cut? Don't they stand to gain even more?
The answer lies in the sensitivity of this gross value addition to the parameters used in computing it: A reduction in the starting salary to Rs 5.5 lakh would reduce the value of the management education by: Rs 200 lakh – (5.5/0.13 - 0.10) = Rs 200 lakh – Rs 183.33 lakh = Rs.16.67 lakh.
Or, an increase in perceived risk, leading to using a discount rate of 14 per cent, would reduce the value of the management education by: Rs 200 lakh – (6/0.14 - 0.10) = Rs 200 lakh – Rs 150 lakh = Rs 50 lakh.
This means that even after a fee reduction by as much as Rs 70,000, students would be losers -- by far -- if any one of the value drivers of management education is affected.
Even if the real value is unaffected by the proposed fee cut, an increased sense of uncertainty in the minds of students can bring the perceived value of management education plummeting! Students might be concerned (rightly or wrongly!) that a reduction of fees by Rs 70,000 might lead to a reduction in value by lakhs of rupees, thus leaving them poorer than they started off!
So, the proposed reduction in fees reduces the real cost to the student by just 15 per cent. But any reduction in the quality of delivery can reduce the value of the education by tens of lakhs of rupees. If we are concerned about the students, especially from weaker economic backgrounds: We should be subsidising not only their fees, but also a substantial portion of their other costs; and
We should focus not on cutting costs, but on identifying drivers of value and then ensuring that additional value is created, not destroyed.
Dr Damodaran is a member of the finance faculty, IIM Kozhikode.
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