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Stanford as a VC

Arillaga, Knight and the Circle of Stanford Life

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Conversation on campus and beyond abounds about the high sticker price of Stanford and other elite universities. So it surprises many that the University actually spends more per student on average than even the cost of full tuition. With aid factored in, the typical student is paying only 20% of the average cost per student to the university

So where does the difference come from? As of Oct 2, 2019, the Stanford endowment totals $27.7 billion with an annual takeout of $1.3 billion, more than 20% of the university’s budget, and is the largest source of funding for academics & financial aid. With such a reliance on the endowment, Stanford’s institutional model requires frequent and sizable donations. 

My goal in this article is to explain the implications of cultivating future donors to life here on campus. Stanford’s funding is dependent on the creation of strong institutional ties during a student’s tenure on campus. Our time here is rife with tailored student experiences replete with a rich residential education and an abundance of esteemed faculty interaction – both a cause and a necessary consequence of the following financial model detailed in a recent paper from Stanford professor Caroline Hoxby:

Stanford, in many ways, is like a Venture Capital firm (VC). Its students are startups and the university creates equity-like relationships through the student experience. After we graduate, a small fraction of us will become very rich (IPO) and the university will cash in through endowment donations. Through this process Stanford sustains its broader goal of benefiting society through world-changing ideas and people as well as strengthening its global brand. Let’s take a look at the numbers.

The True Cost of College

There are many ways to measure the value of college, one could simply look at how much a student pays. Another is to look at how much the university spends on the marginal student. A third is to look at the real value of a college education in your life. In Econ 1’s perfectly competitive market with no externalities, all three are theoretically the same!

It turns out that at highly selective universities, students pay around 5x less than the average cost of educating a student to the university. Moreover, it is almost impossible to know what the real return to a Stanford education is to each of us – and that does not even consider the social benefits that may accrue from a more educated population.

Looking at the data, Stanford’s top revenue generators are its endowment, health care services and tuition. The hospital system, though worthy of its own analysis, is fairly self-contained and much of the revenue is funneled right back into medical facility expenditures. When we take a look at the expenditures side, calculating how much it costs to educate a Stanford student is quite difficult, because the category of compensation, 62% of spending, is very opaque. The university spends money on a vast array of functions – many that are relevant to the undergraduate experience but to varied and imprecise degrees. For example, spending on a GSB faculty member may benefit someone’s undergraduate experience if they do research at the GSB or attend a talk, even if such spending would not be allocated to an undergraduate department on an accounting basis. 

Another paper by Hoxby looked at this question systematically and analyzed the share of ‘student-oriented expenditures’ that are funded through tuition versus subsidy by the school. Here, categories of student-oriented expenditures are instruction, student services, academic and institutional support and operation and maintenance. The study found that 80% of student-oriented expenditures are subsidized and only 20% came from tuition. Around 50% of Stanford students have need-based aid from the university and pay an average of ~$14K. Thus, the average student is paying in the ballpark of $40K, with an implied average cost to the university of 175-200K. Note that this is different than the sticker price of Stanford, which was ~72K last year.

Thus, even on a conservative reading of the data, it seems that it costs far more to educate a Stanford student than the university reaps from each of us. 

But what are other universities like?

Consider a university of median selectivity – tuition covers 70% of costs to the university. Even at schools around the 95th percentile selectivity, tuition only covers 50% of the costs. That’s way more than for Stanford where tuition covers 20%! This is why Stanford is forced to create equity-like relationships in which the university reaps a share of lifetime earnings for at least a small fraction of students. Let’s take a look at Stanford’s goals and how they fit in with the endowment model.

Stanford’s Goals

Understanding a university’s goals is made difficult by their diverse range of actions and priorities. Especially for an institution like Stanford – it is difficult to square having more olympic gold medals than most countries in the world with several Nobel laureates and a boatload of palm trees. Hoxby’s original paper models highly-selective colleges as attempting to maximize their “intellectual contribution to society valued at social returns.” The reality may be slightly more cynical – university leaders skew their definition of “social returns” towards prestige in the eyes of the elite. The university itself claims the endowment exists to promote ‘intergenerational equity’ and correct funding discrepancies between generations. This has some truth, but it fails to explain why the university invests so much per student in the first place. I had the chance to interview Professor Hoxby for this article. In response to a question on why Stanford has such a model, she emphasized a balance between multiple goals. The university aims “not just to produce students who earn a lot of money but to produce students who make the world a better place through invention, scholarship, and social enterprise.”

Generating Return on Investment

An important feature of a VC is generating the majority of portfolio returns through a small number of investments. How does Stanford follow this characteristic? Well, take a look at the distribution of returns from venture-backed startups. Most portfolio companies will not become Uber-rich and instead produce minor losses. Similarly, for Stanford, most students will not donate in any significant way. But it’s the Arillaga’s and Knight’s of the world that carry the rest of the student population and justify the university taking an equity stake in each of us by subsidizing our education. The returns on the portfolio, like an undergraduate class, are driven by the long tail. As Hoxby told me, Stanford’s model works because students “have the aptitude to make productive use of educational resources, that are usually much in excess of what they and their families could pay for” and earn so-called supernormal returns, returns much greater than the normal return on investment. But none of us actually sign a contract agreeing to give away a share of our future income – so how does Stanford create these equity-like relationships?

Creating Institutional Ties

Conventional wisdom argues that donors give to Stanford for many reasons, including (i) influence over the admissions process (ii) a desire for the public eye (iii) an actual belief in the educational mission of the university and more. Under all these factors lie another necessary component: strong ties to the particular university. Why donate to Stanford over thousands of other arguably more productive charitable opportunities? As Malcolm Gladwell recently said, Phil Knight’s donation to create the Knight-Hennessy scholars program was probably an offensive waste of money relative to other uses.

Regardless of whether you agree with Gladwell, the VC-endowment model of a university has a number of implications for how Stanford creates emotional institutional ties:

Sports: Stanford and many other highly selective colleges invest heavily in athletic programs despite most of them running a deficit. Even Division I football, the largest revenue generator of all sports, runs at significant operating deficits in most schools. At some level, it is about prestige – but one reason why prestige matters is that it enriches Stanford culture and the student experience, which in turn increases donations and eventually the size of the endowment. Sports helps create culture and identity – a key portion of institutional ties.

On campus-experiences: Just like with sports, Stanford cares heavily about having strong on-campus residential experiences and is willing to invest in Cardinal Nights, dorm culture,  and more. Of course, there are other reasons why these phenomena occur, but it seems like much of the activity of Stanford fits with the VC model. To put it simply, Stanford needs its students to have liked college far more than the average educational institution in order to sustain its institutional model.

Admissions: In order to have high levels of resources per student, admissions must be highly selective. In Hoxby’s words, “there are very real constraints on how many students Stanford could admit while still maintaining its quality. These constraints are not arbitrary, but fundamental to Stanford’s (and its peer institutions’) method of financing.” And sure, CS classes are massive – but the very CS students who have large lectures benefit from a dense startup accelerator + VC network that greatly advantages current students and future alumni. Lastly, it goes without saying that Stanford and students alike tout the school’s ~4% acceptance rate. 

Corporate recruiting: It’s probably not a coincidence that Stanford is very happy to have large corporate recruiting events such as CS Forum where companies hand out free swag and gain brand recognition. Stanford needs us to work at these places to become rich and donate back. From the university’s standpoint, we cannot all work at nonprofits or even become academics – it’s not financially sustainable!

The Circle of Stanford Life

Stanford needs us to love our time in college. To stay on-campus all four years and create friendships and memories that last for a lifetime. To obtain a sense of obligation towards the university that will cause us to donate as alums. The university cannot afford to have us all focus on social impact or public service. Though of course, it hopes a portion of us do. Instead, it needs a sizable fraction of students to amass large sums of wealth and create lasting institutional ties and for a couple of us to give back. The next generation of students can then enjoy the benefits of a twenty-seven billion dollar endowment, gain a sense of obligation to the university and grow up to become future donors themselves – continuing the virtuous cycle that is Stanford’s institutional model. 

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Arjun Ramani '21 is The Daily's Data Director. He hails from the Hoosier Heartland of West Lafayette, Indiana and is studying economics and computer science. Contact him at aramani3 'at' stanford.edu.