Andrew Connolly is Chief Financial Officer at the University of Exeter.

A company that doesn’t know the cost of its products or the financial margins of its different product lines is probably doomed to fail.

Thankfully in HE we’ve been doing a form of costing since 1998 when the Transparent Approach to Costing (TRAC) was introduced. Despite its limitations TRAC data provides a wealth of rich insight into the financial performance of a University that can be used to shape strategy, inform decisions and help us plan for financial sustainability.

TRAC cynics start here

I suspect the reaction to those of you who have got this far is to roll your eyes or groan. Pretty much throughout my career, and I started in HE two years before TRAC was born, whenever I mention TRAC to academic audiences I hear muffled scoffs of laughter. It’s enough to make a CFO find ways of avoiding Senate.

Let me nail my flag from the outset. I am a costing enthusiast. Yet despite 22 years of doing TRAC, despite the significant sums that have been invested nationally in honing our costing methodologies (the TRAC guidance) I believe most of us have only just reached the base camp of costing sophistication.#

What is TRAC anyway?

It’s a form of Activity Based Costing (or ABC), a methodology developed for the manufacturing sector in the late 1980s. At its most basic it takes our total costs (think staffing and overheads) and using the ABC methodology attributes full costs to our activities (think teaching and research). The sectors TRAC Development Group published a useful guide for senior managers in 2015 explaining how it works. ABC can serve multiple purposes:

  • allocating staff costs and institutional overheads to activities (eg calculating cost-recovery for research activity to assess financial sustainability),
  • allocating institutional overheads to academic disciplines (eg. assessing the surplus/deficit positon of a discipline by matching full costs to income streams)
  • for ‘costing products’ to inform their pricing’ (eg. the ‘full economic cost’ or fEC rates used to cost/price UK research council grant applications).

Most of us do all of these things to varying degrees of enthusiasm and sophistication. We do it because we have to (submit TRAC returns to our regulators, calculate fEC rates for research grant applications) and some use it in management information packs to assess the financial performance of faculties and disciplines.

Very few of us genuinely use it to cost teaching. It was telling that in Phillip Augar’s commissioned report on costing teaching, KPMG had to develop their own costing model, abandoning TRAC for teaching data. I know from discussions with some of my peers they simply weren’t in a position to produce the data. That speaks volumes. After 22 years of TRAC, the cost of teaching should surely just roll off our embedded costing systems?

Why hasn’t the sector embraced TRAC?

When money is flowing in – strong student demand, a £3k to £9k fee, removal of the student number control cap – the task of senior managers has been to bid for, earn or allocate additional income streams and then spend them. With roughly 40 years of growth, and few will remember the last serious cuts to HE back in 1982 (I was doing my A levels), managers have honed their skills at balancing the books, making sure income exceeds expenditure by just the right amount.

Until now, many in the sector haven’t had an imperative to manage the financial margins of activities or disciplines, partly because they’ve been operating in a rising market fuelled by deregulation. Of course I am generalising here, there have been financial challenges for some that have involved hard decisions on cutting and down-sizing. The point is that in the commercial world managing margins is an everyday driver to create resource – either for investment, to fuel executive bonuses or for shareholder return. While we’re not out to profit maximise we need resource to invest.

The sunny uplands of growth have bred a cadre of senior academic and professional service leaders who excel at spending money but who would find managing financial margins a challenge. To be fair, deregulation of our markets is still a relatively recent phenomenon, it was only so in 2014/15 that student number controls were abolished. Add to the 6 years of exposure to competitive markets, the 8 years of the fixed £9k tuition fee, excepting the one-time permitted £250 increase in 2017 (unless you’re in Wales), the 10-years of the demographic dip in the 18-year old population against a rising tide of pay and pension costs, then the finances of the many are now being squeezed at both ends.

Product costing systems should be an essential part of our tool kit in managing this challenge. And here is the nub of my argument – it’s likely that a higher proportion of our future resource to fund investment will have to come from within, by freeing up resources that are currently misallocated and reallocating them to new activities. To do this we need to get to grips with product costing, focus more on margin management and reduce our assumptions that growth will rescue us.

We may be to blame

It’s never a good start when, back in 1998, TRAC was imposed upon us. We signed up to it because TRAC offered the prospect of evidencing just how underfunded research was – and it worked. As a direct result of its compelling evidence there were successive increases in public funding. But the imposition of TRAC, along with the time-sheets then required to allocate academic staff costs to activities, tarnished its brand.

Six years after the introduction of TRAC, in 2004, the term full economic costing (fEC) entered our lexicon as a system to both cost and fund research from UK research councils. But for most of us our product costing systems haven’t got much beyond this stage, and we’ve accidentally ended up institutionalising confusion between cost and price in the form of fEC.

At the heart of TRAC is the notion that full economic cost comprises accounting cost (declared in the financial statements) + a margin (technically the Margin for Sustainability and Investment). So the theory goes that if our pricing or funding is set to deliver 100% of our full economic cost (=cost+margin) then it means we are generating surpluses sufficient to fund our capital investment. This is the road to sustainability and I have no argument with it, other than with its semantics.

When we present our TRAC data to Senate, we start by explaining that last year’s University/faculty/discipline surplus was actually a deficit (because TRAC treats the margin as a cost) – as a result of recasting our financials from an accounting to an economic basis we confuse and lose the audience. It results in mixed signals; on the one hand we’re in robust financial health (our financial plans and financial statements prove it) on the other we have huge TRAC deficits. This makes it easy for academics to marginalise and dismiss TRAC.

Fixing the terminology

TRAC has consistently shown that research does not cover its full economic cost, or alternatively, and in language I am careful to avoid at Senate, research loses money. This is always guaranteed to alienate our talented PIs who, on the one hand are encouraged to earn more research income by our VCs and on the other hand are told that research doesn’t pay by our CFOs. Of course the data is presented in a considerably more nuanced way than these blunt statements. Yet, the fundamental signal is that research is bad financially. Rather than accept this objective fact and agree on the strategies required to address or accommodate it, academics chose to pick a fight with TRAC itself. It’s an easy target. Yet everyone intuitively understands the terms cost and price and the need to generate a margin for investment. That doesn’t need a primer from the CFO. The language of TRAC constructs a needless barrier by the invention of the term full economic cost and its confusion with price.

All of this is easy to fix. Re-calibrating the language of TRAC to a simple, cost is cost. A simple change of language and terminology will liberate us from tortuous TRAC debates. Maybe we need a change of name as well to address TRACs historical baggage – Costing in HE perhaps, it does what it says on the tin.

Once we’re liberated, the next task is to develop teaching and other costing tools, embed costing into our everyday management information, enabling us to begin to get a grip on understanding and managing financial margins to inform resource reallocation. Those that get a grip of this will have a competitive advantage compared to those that continue to operate TRAC as nothing but a requirement for regulators and research funders.

One response to “Why costing really matters – and how to make it better

  1. An interesting article. As a Finance Manager working in a faculty, costing is certainly embedded into the management information I provide, but I would never dream of using TRAC data for any internal reporting.
    In my view, absorption costing is a necessary evil – it enables the organisation to meet its external reporting requirements and does provide some indication of the issues that contribute to the financial performance of the institution at a high level. However, in terms of being able to drill down into analysis of the financial performance of departments or programmes, I find it rarely provides any useful insight.
    To understand the financial performance of a “product” it is necessary to distinguish between direct costs and indirect. Usually, the local manager will have discretion over the former, but not the latter. The ability of a product to cover its direct costs should be the first test of its financial performance. The extent to which it can then meet the level of overheads charged to it is a secondary matter; but it should be borne in mind that those overhead costs have usually been allocated through a relatively blunt model, and that the methodology of that model, along with the overall magnitude of overheads themselves could materially affect the apparent financial performance of the end product. It would be misguided to hold an academic manager responsible for their programme apparently running into overall deficit, if that deficit was caused by spiralling costs of central services that are charged to the programme, or, for example, if the business case that supported the erection of another new building with all its associated running costs was flawed.
    TRAC clearly has its uses – at University and sector level it can be a powerful tool, but in terms of understanding financial performance, driving financial improvement and influencing decision-making it has little to offer.

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