Analysis: The first rule of business - cover costs

Why does an academic consultant cost about the same per hour as a plumber? Claire Sanders reports on how universities are selling themselves - and staff - short.

Plumbers charge an hourly rate of about £35 - often more. A lawyer advising a university can charge at least £100 an hour. An academic acting as a consultant, or heading a research team, often charges about £35 an hour. Is this right?

Since 1997, a small group of people has been working quietly to transform the costing and pricing culture of United Kingdom higher education.

Many academics will have come across the work of the Joint Costing and Pricing Steering Group through the Treasury-inspired transparency review.

The transparency review asked it to develop a sound method of costing university activities to establish how public funds are spent on research.

But the work of the costing and pricing group has far wider implications.

Once universities have a sound basis for costing their activities, they will be able to point with greater force to funding gaps in research and teaching. The nine pilot institutions involved in the transparency review pilot have already been able to point to funding gaps in research, to underfunding by the research councils, government departments and private sponsors, to the extent to which overseas and postgraduate fees are plugging these gaps, and to the long hours academics and support staff work to keep universities going.

There is also evidence of underfunding on publicly funded teaching, which could become more apparent as more new universities report their costings.

The deficit is £21 million on an income of £460 million. This 5 per cent is not considered to be statistically significant at this stage.

Once universities can cost their activities, they can price them realistically and move away from the low-price culture that, many argue, has held them back for too long.

For those keen to move away from reliance on public funds, this is as crucial a step as being free to set student fees. Indeed, without a proper costing base, how can universities even begin to set their own fee levels?

It has been a condition of the financial memorandum between the funding councils and all institutions for several years that they "should have regard" for the full cost of research and other activities in their financial planning.

Once a methodology is in place for establishing the cost of activities, universities that can be shown to be seriously undercharging could face penalties. This will be an area to watch as it is government departments and research councils that do not pay full costs. If the government has made it a condition of grant that universities charge full costs, how can it refuse to pay?

The group was set up in 1997 under the chairmanship of David Westbury, vice-principal of Birmingham University. It includes representatives from all the funding councils as well as Universities UK, Universities Scotland, Higher Education Wales and the Standing Conference of Principals.

Its original aim was to improve the costing and pricing activities of universities, to give academic managers better information. "Universities have long been moving from an environment where many of the prices were set for them, and where a centrally determined budget was just allocated down, to a situation where they had to generate income and set prices," Professor Westbury said.

"As a consequence, they needed to move to activity-based costing. This is a well-established method of accounting in the commercial environment, where a company has to decide how much an activity costs before it can decide how to finance it."

Then, in 1998, came the transparency review. It followed Labour's first comprehensive spending review, which awarded £1.5 billion of additional funding to higher education.

But the Treasury made this conditional on the sector becoming more accountable for the way that public funds are spent in universities and colleges. It wanted the dual support system for funding research unpicked so that it had clear information on exactly what was the funding gap for research, highlighted by Dearing and a number of other reports.

The review is being overseen by the Science and Engineering Base Coordinating Committee, chaired originally by Sir Robert May, chief scientific adviser to the government, and now by his successor, David King.

The SEBCC set up the Transparency Review Steering Group, chaired by John Taylor, director general of the research councils.

The steering group delegated the task of developing methods for transparent costing to an existing body - the Joint Costing and Pricing Steering Group.

JM Consulting was commissioned to advise on methods that could be used across a diverse sector that would meet institutions' internal management needs and those of external sponsors of research. The review has gone well beyond research, in part because research cannot be costed without costing other activities. These come under the convenient headings of teaching, research and other - "other" being consultancies, catering, residencies, and anything that does not fall into the first two categories.

Once the method is in place, it should satisfy any transparency requirements coming out of the departments for education and employment, health, the Home Office, the Ministry of Defence and even the highly demanding European Union.

Yet another significant effect of this group's work is that it could unravel the "knock-for-knock" arrangements that medical schools have with the National Health Service. "It will be an area for further study," said Professor Westbury.

"For the purposes of the transparency review, we are assuming that it is in balance. My guess is that it is not and that universities are not being fully refunded by the NHS."

Within six months, JM Consulting had submitted a report to the SEBCC and it was endorsed in June 1999. The consultancy was clear about the implications of the review.

"At a national level, TR information will show true costs and (probably) shortfalls in the funding of higher education activity for the first time. It is likely to show a 'funding gap'." It went on: "All reviews of this nature will affect your institution's internal resourcing decisions and may affect your department."

And, heralding a new era: "Many institutions plan to become increasingly independent of public funding. To do this, it is important that they are aware of the full costs of activities, so that they can negotiate their prices with a good knowledge of what funding is needed, from sponsors or from internal subsidies. However, too many sponsors are currently paying less than full cost (without good reason). This applies to teaching, research and consultancy contracts: it applies to charities, the European Union, and most government departments. It applies to DoH nursing contracts.

"Institutions, working on their own, have found it very difficult to turn this around. Your institution will have suffered from this, and the resources available to you to do your work will be less as a result."

The method developed by JM Consulting - and endorsed by the SEBCC which, in turn, agreed to undertake a hearts-and-minds exercise to ensure all government departments would be happy with the method - requires universities to calculate the total costs of teaching, research and "other", at institutional level. Teaching and research are split between publicly and non-publicly funded activity. These five figures have to be submitted as an addition to the university accounts to the funding councils once a year.

The implementation has been phased, with nine pilot universities trialing the method, followed by a further group of 23 research-intensive institutions and then the rest of the sector.

"Full transparency by the use of robust methods is not expected to be achieved before the end of 2003-04," said JM Consulting.

To guide institutions, the Transparent Approach to Costing Manual was produced in July 2000, based on a September 1999 draft.

Important issues are tucked away in the methodology.

The most visible, beyond the finance office, is time allocation. The manual is flexible in its approach. It says: "The area of most concern to institutions will be the time allocation process since this is the most costly and visible part of the implementation of the transparency review."

As a minimum requirement, institutions are expected to supply an annual retrospective time allocation signed off by the head of department, backed up by in-year time allocation sheets (for example, diaries) to support these retrospectives.

What this means is that an individual academic might complete only three in-year returns (each covering a third of a year) every five years. The Association of University Teachers and lecturers' union Natfhe are concerned at the pressure these sheets put on staff.

"We support the model developed by University College London," said Paul Cottrell, assistant general secretary at the AUT. "It minimises bureaucracy and form-filling and is anonymous to safeguard against misuse of data."

The July manual differed from the September 1999 draft in that it contained more guidance in two key areas. The first was attribution of costs in medical and dental schools. These are the "knock-for-knock" arrangements that Professor Westbury believes will require further study.

The second was cost adjustments - in particular the infrastructure adjustment and the cost of capital employed. These two adjustments are crucial as they show the funding gaps for buildings and investment.

The manual says: "Institutions should make some adjustments to their total institutional costs as reported in the published financial statements (but not to the financial statements themselves). These reflect the fact that the financial statements in most cases understate the full costs. The adjustments bring in the full economic costs of maintaining the institution's infrastructure (estates) - which is usually understated in the published financial statements. The adjustments also bring in an additional cost-plus element - called the cost of capital employed. This is required to reflect the rate of return that all businesses need to generate for innovation and development, and to cover the costs of financing."

This is called a full-cost approach. One finance director said it added as much as 15 per cent to his university's economic costs. Others said 35-40 per cent. One gave a figure of £4 million.

Professor Westbury said: "The infrastructure adjustment is based on the full cost of maintaining infrastructure. We have built in the cost of keeping a facility up to the level needed - not just current costs. It is actually based on insurance values. The cost-plus element is based on the government accounting conventions used by the MoD in its contracts. All commercial businesses use such an approach - it is impossible to sustain growth and develop in the future without it.

"What the costing methodology is showing is that funding levels across the dual support system are too low, not that the system itself is at fault."

A clearer picture of the funding gaps will emerge in July this year when more institutions report. This is frustrating for Mr Cottrell. "We feel that the unions have been shut out from this process. Why can we not have aggregate figures now? This was meant to be a transparent process and it is not. How do we know that the Treasury will find the methodology suitably robust, especially as institutions have been allowed a fair degree of flexibility?" he said.

Professor Westbury said: "The new costing systems should give confidence to government that the money it invests is used properly and for the purposes for which it was given. The funding councils cannot publish aggregate figures until the methodology is firmly in place."

The group has started to move ahead on pricing with the production of a toolkit last October. "Universities have had to diversify their range of activities and seek new activities and markets both in the UK and overseas," it says. "To ensure that each institution meets its strategic objectives and maintains its financial viability, it is vitally important that the financial aspects of its various activities are addressed adequately."

"I believe it will take a concerted approach by universities to ensure that they start pricing realistically," said Professor Westbury. "It is no good undercutting each other. Price should be related to the value of the product. For example, overseas student fees reflect the value of higher education and the international market."

Once the work of the group is completed, he would like to see bodies such as UUK take forward the implications. "There is a substantial advocacy job to be done on behalf of universities," he said.

But Liz Allen, higher education official at Natfhe, is cynical. "This is just one of those costly exercises, where staff have had to fill in endless forms to prove once again that universities are underfunded. Like Bett, it could turn out to be a very demoralising exercise if nothing changes."

Tony Bruce, policy development director at UUK, said: "We need to both convince the sector of the value of this exercise and ensure that government departments and other sponsors realise that universities can no longer subsidise activities."

UNDERPRICING 'HAS TO STOP'

Strathclyde

David Coyle is director of finance at the University of Strathclyde and represents the British Universities Finance Directors Group on the Joint Costing and Pricing Steering Group (JCPSG).

Like most universities, Strathclyde now receives significant funds from the private sector, and needs to cost and price its activities accordingly.

"The infrastructure and capital employed adjustments are crucial. I've seen a number of university accounts recently and virtually everyone is in deficit. When you add these adjustments, the situation becomes much worse," Mr Coyle said.

"The exercise has undoubtedly been viewed by academics as a bureaucratic imposition. We must be able to use this information to get real results for universities. Government departments are the big underfunders."

Heriot-Watt

Heriot-Watt was added to the original list of eight pilots because it was already a long way down the road in developing strong costing and pricing policies.

Stephen Paterson, director of finance, said: "We do so much work with industry and the commercial sector that we needed a proper costing policy. As with many other universities, it is our 'other' activities that are funding research. What really jumps out is that government bodies are seriously underfunding research."

Like Mr Coyle, he sees a number of university accounts. "I would say 75 per cent are in deficit and that the hole is in research. Once the infrastructure and capital adjustments are made, then you add 15 per cent on top of total expenditure. For universities with older estates, the gap is bigger."

Portsmouth

Portsmouth University is the only new university among the pilots. Malcolm Ace, director of finance, said: "For universities building up a research base, the underfunding of research has a knock-on effect through the workings of the research assessment exercise. It makes getting on the first rung of the ladder harder."

Mr Ace feels it is important that all government departments accept the methodology and its findings. "We have a lot of contracts with the NHS. We have to see the NHS making a bigger contribution to the overall university costs.

"Universities end up apologising when they charge £350 a day for a senior academic as a consultant. This has to stop," he said.

Surrey

Surrey University is also one of the pilots, and Glynis Breakwell, pro vice-chancellor, is also a member of the JCPSG.

She said: "The work has thrown up two major conclusions so far. First, research in universities is not properly priced in relation to the cost base. This is across the board. From research councils to government departments and especially the European Union, the infrastructure contribution to indirect costs is far too low. Second, there is no evidence in our case that other public funding streams are subsidising research activity."

Tony Knapp, director of finance and a member of the Transparency Review Steering Group, said: "Surrey generates a lot of its own income and we need to have a clear costing and pricing policy. Without it we could make serious mistakes. Universities have to understand what they are doing to themselves and to other universities, when they undercharge just to gain contracts in a competitive market. We need to change the culture in the sector on pricing."