An unusual perspective on graduation. (Kenneth C. Zirkel/iStock)

The effects of growing income inequality continue to ripple through the American economy as every sector from retailers to automakers try to figure out how to appeal to an increasingly bifurcated consumer base — the rich, the poor, and a shrinking middle class.

In the retail and restaurant worlds, the strategy among the likes of Walmart and McDonald’s has long been to gain market share with seemingly endless discounts. But that approach is showing signs of aging as consumer preferences shift and lower prices weigh on the bottom line.

The same is now true for higher education. Most colleges and universities have managed to fill their classes each year by employing sophisticated discounting strategies that extended cut-rate tuition rates to just enough students to encourage them to enroll. In the past decade, those discounts not only got much bigger, but schools offered them to more students — including those who used to pay full price — to entice them to campus.

This week, the association that represents CFOs in higher education released its annual report on tuition discounts. You can find details on the full report here in a post by Danielle Douglas-Gabriel, but the overall findings paint a worrisome picture for much of higher education. The average discount for first-year students reached a staggering 47 percent — that’s nearly half off of the published sticker price of tuition, and up from around 40 percent just seven years ago.

That’s not the only alarming trend. In reading the report, here are three others:

1. The declining value of a degree. If everyone is getting a deal on tuition, is anyone actually getting a deal? At some point, the discount games that colleges play make them no different than car dealers trying to move vehicles from the lot at the end of the month.

The problem is that, unlike most other sectors of the economy, the sticker price of colleges and their cost of doing business do not scale proportionally with quality. In other words, we have colleges that graduate nearly 100 percent of their students and colleges that graduate just 50 percent of their students, but both types essentially charge the same sticker price.

The discounts many colleges offer are not based on their mission or a deep-seated belief about the composition of their classes. They often tweak prices more for certain majors that are less popular or to attract academic talent regardless of financial need. College leaders have criticized students, parents, and policymakers for treating higher education too much like a commodity, but in many ways schools have done that to themselves by adopting discounts and confusing consumers on the real value of a degree.

2. Slower revenue growth. When Walmart and McDonald’s offer discounts, their hope is that they can make up the lost revenue with volume — by attracting more customers. But most colleges are capacity-controlled. They can’t simply take more students to get more revenue, and at some point extra students add to the marginal cost of doing business.

The report released this week points out that rising discount rates have led to much slower growth in something called “net tuition revenue,” the cash schools have on hand after giving out financial aid. That’s money they need to spend on faculty salaries, new programs, and the upkeep of the campus.

“The data appear to indicate that gross tuition price increases have been largely offset by increased institutional grant aid to students,” the report said.

This type of discounting ultimately will result in a death spiral for colleges. Every year, a college raises its sticker price but derives a smaller share of that increase in the form of actual cash. Eventually, its revenue flattens, or worse, shrinks. A few years of that trend is not sustainable for most colleges that rely on tuition for the bulk of their revenue.

3. A grim future for small colleges. Small institutions discount their tuition more than other types of colleges and universities. Their discount rate for first-year students reached 50 percent this year.

Of the nearly 5,000 colleges and universities in the United States, about 40 percent enroll fewer than 1,000 students. Since 2010, those schools have been shedding the most enrollment, a decline of 5 percent compared to the largest institutions — which have more than 10,000 students and which have grown slightly, on average, according to an analysis by Parthenon-EY (see chart).



Source: Parthenon-EY

Smaller institutions are obviously working off a smaller base of students and revenue. Discounts have a disproportionate impact on their bottom line and a loss of a few students really matters to their spending. No wonder that since 2007, most of the 72 colleges that have closed had enrollments of less than 1,000. More are likely to follow if they don’t merge with larger schools in the meantime.

You only need to glance at this report on tuition discounts to get a sense of the enormous challenges facing higher education. Now the question is whether higher-education leaders will abandon their discounting strategies like other sectors of the economy or continue their race to extinction.