The pursuit of hire education

Across England, thousands of 17-year-olds are calculating the cost of getting an undergraduate degree, and it is not only the thousands of pounds of debt they will incur that is on their minds. They are attempting to determine which degrees will offer the best returns on their investment over the course of their future careers.

Should they study accountancy, whose graduates earn on average vastly more than arts graduates (42 per cent more for men, 37 per cent more for women)? Or opt for history, where the wage premium for men compared with an arts degree is still 11.7 per cent, but for women just 0.95 per cent?

Students are discovering that their choice of institution also has an impact on future earnings. Six months after graduation, those who have attended the University of Southampton, for example, earn on average around £2,000 more than graduates of the University of Manchester. But is this gap big enough to influence the choices of prospective students?

In the wake of the Browne Review of higher education funding and student finance, the Conservative-Liberal Democrat coalition passed legislation that will allow universities in England to set their own tuition fees. From September 2012, English universities will be able to charge home and EU students fees of up to £6,000 per annum for undergraduate degrees. Institutions that show adequate support (in accordance with yet-to-be-defined criteria) for students from disadvantaged backgrounds can charge even higher fees of up to £9,000 per year. Management teams up and down the country are faced with the daunting challenge of deciding how they should price themselves in comparison with their competitors. They must also consider whether they should vary fees across different courses, and may even face the difficult decision to close loss-making courses.

In theory at least, the demand for a particular degree course will be heavily determined by the expected economic value of that qualification. The economic value, in terms of earnings, varies substantially not just by subject but also by institution. If graduates with a particular degree go on to have very high earnings, then theoretically they should be willing to pay more for that course - and hence the university can charge more.

Of course, this relies on students knowing how much they are likely to earn in the future, and how it might vary with their higher education choices. Research conducted by the University of Southampton in 2009 suggests that most young people rely on short-term indicators such as initial salaries and employment rates for new graduates, and only on a rudimentary level. University undergraduates overestimate their starting salary by an average of £1,600 (10 per cent), and predictions made by first-year students were even less accurate, overestimating by £3,000, or roughly 20 per cent.

The financial impact of the new fees structure will soon change that state of affairs. Faced with the prospect of substantial debt, students will increasingly turn to online resources in a bid to make better-informed educational and vocational decisions. Websites now exist that allow users to compare how employment outcomes such as starting salary, starting occupation and unemployment rates vary by course and institution. Likewise, they allow young people to compare how pay rates for graduates and non-graduates vary at different points in their careers. Users can also search for particular occupations, determine what subjects they should study to land a particular job, and get details of average pay rates in that profession.

Such online resources are set to become much more influential as they offer both young people and universities an insight into an important part of the fee-setting and higher education decision-making process.

For example, data drawn from the Higher Education Statistics Agency and the Labour Force Survey suggest that students from notionally similar institutions earn (on average) quite different amounts: six months after graduation, salaries for Southampton graduates averaged £23,160 compared with £21,220 for those from Manchester.

The data also indicate that different degree subjects lead to different occupations, and hence different levels of future earnings. Presently 14.2 per cent of English studies students are working as teachers six months after graduation; over a 45-year career, secondary school teachers can expect to earn a gross salary of approximately £1.8 million, and primary school teachers £1.6 million (calculated using the average hourly salary figures). By contrast, around half of economics graduates enter an economics or finance-related field, and the gross lifetime pay of finance and investment analysts, for example, stands at roughly £2.9 million. The implication for higher education institutions, particularly teaching universities, is that they need to consider such differentials - and the extent to which students understand such differentials - when setting their fees.

In practice, universities are likely to set the broad level of their fees in accordance with the reputation of the institution as a whole. Institutions will likely seek to price themselves at a similar level to those they deem to be comparable in terms of quality and reputation, as measured, perhaps, by some kind of average of their research assessment exercise scores. Of course, as institutions are not allowed to collude and jointly set a fixed price, there is likely to be an element of gamesmanship, with institutions seemingly having little to gain by announcing their prices first. It seems likely, therefore, that when the first institution blinks and sets a level, others will follow.

Yet those managing higher education institutions must first identify exactly who their competitors are. These may be defined within a relatively small geographic area if the university competes in a local or regional market, or they may be those with a similar "reputation" if they are competing for students across the UK. For the highest-ranked institutions, there will be the added dimension of global competitors - it is unlikely that the universities of Oxford and Cambridge, for example, will want to appear unduly expensive or inexpensive when compared with universities of similar international standing.

Yet the argument that competition will bring variation in prices between institutions rests on the premise that there are not substantial and costly "signalling" effects. In other words, a university with a less prestigious reputation may not wish to put out a signal of low quality by charging lower fees. In the past this led to almost every university choosing to set tuition costs at the maximum amount permissible, which was £3,000 per annum when top-up fees were introduced.

Again, this will change as students use online resources to research the financial implications of specific degrees. Rather than a signal, fees will become just another element in prospective students' calculations.

As with any cost or service provided in a competitive marketplace, it makes financial sense only to offer courses that cover their own costs. When considering differential fees between subjects, universities must therefore take into consideration the fact that certain subjects, including many in the sciences, are particularly costly for institutions to provide. This has been recognised by the government in its maintenance of the teaching grant for certain subjects. Yet it is also likely that, owing to small class sizes, some non-science courses will be expensive to deliver - and they are no longer subsidised by the government. Institutions will therefore need to make a decision about whether to cross-subsidise these courses, charge more for them or drop them.

The decision to cross-subsidise some offerings may not be defensible from a purely financial standpoint, but some institutions may do so to ensure the survival of courses that are seen as essential for a university to provide.

The second option for universities - to charge more - will be constrained by the aforementioned factors: the pricing of their competitors, graduate employment rates and prospective students' perceptions of how valuable the course is. Hence it seems likely that, at least on some occasions, dropping courses may be the only option that makes financial sense.

But there are other issues that those setting fee levels in higher education institutions must consider. For example, a proportion of students will end up having some of their debt written off as they will not earn enough over their working lives to fully repay their loans. In other words, they will end up not paying back some of their tuition fees and thus the sum they paid for their tuition will be below the figure advertised by the institution.

If students understand this, then they may not take much notice of the "advertised" price. Institutions may therefore choose to set fees at high levels because students understand that the extra cost they incur will be written off, and thus become insensitive to price.

Although the recent government reforms addressed the cost of only undergraduate education, there may be some knock-on effects in the postgraduate market. As fees for master's degrees are neither subsidised nor underwritten with income-contingent loans, students' growing debt aversion in response to undergraduate fee increases may result in reduced demand for taught postgraduate courses.

Finally, the development of a market for higher education in England will offer the opportunity for universities to innovate. It would take a brave institution to start such a trend, but we may see some adopt marketing strategies and promotions that are common in higher education sectors elsewhere.

One option is to follow US institutions' lead by bringing in some kind of price discrimination. Most US state-funded universities charge lower tuition fees to those who come from within that particular state; some, like the University of Wisconsin-Madison, even offer reductions to residents of that city. Alternatively, could institutions try to tempt young people with the offer of a free MSc year if they do their undergraduate studies at that institution? Indeed, another issue that universities will have to consider over the longer term is whether to bring their postgraduate tuition costs in line with their undergraduate fees, and when such a change might take place.

Just how these factors will play off against each other will be revealed only in time. What is certain is that English higher education institutions have a number of key decisions to make in a short time. This will involve some difficult choices, and it is unlikely to be a straightforward process for either institutions or prospective students.