Part 5: The university's strategic assets
Introducing Hart Assets
This is the fifth part of an eight-part essay, ‘So, You Run a University?’. This essay is authored by Darcy W.E. Allen, Chris Berg, Sinclair Davidson, Leon Gettler, Ethan Kane, Aaron M. Lane and Jason Potts. Previous parts: Part 4, Part 3, Part 2, Part 1.
The parody account on Twitter “Associate Deans” tweeted:
Just to be clear: You can't teach face-to-face because of health concerns. And you can’t (or won't?) use the digital learning system to teach online. Your research isn’t that good and it isn’t funded. So remind me again, why are we paying you?[1]
This question would both stump and infuriate most faculty. Yet it is a good question. One of us (Davidson) retweeted, paraphrasing the Forrest Gump character: “... and just like that, Universities entered the 21st century.”
The university platform is under unprecedented stress from technological acceleration and a global pandemic. Decisions need to be made. Should you shrink or expand? Do you really need that department, or that Acting Deputy Associate Dean (Research)? Can you sell off or outsource some teaching? Maybe now is the time to make those risky investments you’ve been discussing for years, or sell a campus.
What you do depends on what type of university you are. While we get to the three types of universities in the next part (spoiler: elite, specialist and platform), to understand that we need to broach a critical question: what is the true strategic asset of your university?
You probably think you know your strategic assets. Your answer is probably too complicated, tied up in the muddiness of a 15-sided market. Your strategic assets are probably not what you think (and there are probably fewer of them than you think). One thing is for sure, they are definitely not what the tenured faculty think. Whatever you do, don’t ask the faculty.
In this part we introduce you to a new and indispensable concept: ‘Hart Assets’. Your Hart Assets are the key assets that you should never sell. You cannot trust other people with your Hart Assets. You must identify them and protect them at all costs. And so we begin by taking you through a quick seminar on modern microeconomics of incentive design and contracting in a complex firm. We’ll take questions at the end.
Incentives and opportunism inside universities
Adam Smith—the founder of modern economics—had a very poor impression of the quality of teaching at Oxford University. Smith had been a student at Balliol College and wrote, “In the university of Oxford, the greater part of the public professors have, for these many years, given up altogether even the pretence of teaching”.[2] Smith had a theory to explain why teaching at English universities was poor, while Scottish universities enjoyed better quality teaching. As he put it, English professors had no incentive to teach well because they derived no income from their students per se. They were paid irrespective of their classroom performance.
Good teaching is unobservable. There is a monitoring problem and a metering problem. Observing the inputs into teaching is easy: Does a professor attend classes for a given number of hours per week? Does a professor have appropriate slides? Does a professor provide feedback on assignments in a timely manner? Observing the outputs of teaching is hard. Whether or not a student has actually learned anything of value in a class—beyond passing an examination of some sort—is unknown. Perhaps it can never be known. Of course, student satisfaction is regularly measured, but positive evaluations do not necessarily correlate with learning outcomes.[3]
University graduates are often able to retell horror stories of old Professor Jones (names have been changed to protect the guilty) who had never updated their notes or slides since they had been a student, never changed their clothes, was obnoxious or downright disdainful towards their students, but was nevertheless an excellent researcher and so was left alone by the university authorities.
These horror stories are fortunately becoming rarer over time (nowadays, Professor Jones would never see the inside of a classroom, if for no other reason than management would not allow such a drag on the student evaluation scores).
But we need to understand why these bad employee behaviours—shirking, laziness, lack of monitoring—are much more pervasive in the academic world than the business world. Sure, they exist in business. But we all know it’s worse in academia. There are two main reasons for this. First, universities do not have an explicit profit motive. And second, the business world deploys explicit mechanisms to suppress this sort of behaviour.
To suppress some of these behaviors we need to ask some odd questions. Thankfully economists have worked on these questions for over half a century. And they’ve introduced a range of concepts that are central to identifying your strategic assets: transaction costs, opportunism and asset specificity.
Why firms exist
Ronald Coase (1910–2013) was an English economist who won the economics Nobel in 1991 for asking an apparently silly question very early in his career: if markets are so good at allocating resources, why do firms exist?[4] This question always strikes hard-headed practical people as being entirely self-indulgent. To many it is obvious why firms exist.
Coase’s question was subtle but made a deep contribution to how economists think about the world. A lot of economic activity takes place within firms and by firms, Yet in the 1930s economists had not incorporated firms into their thinking. There was some idea of what firms did in an accounting and legal sense, but economists had no idea what it was that firms did in an economic sense.
To explain why firms exist, Coase argued that using markets incurred costs. When you transact with others you need to know who you can transact with, at what prices, what goods and services are available for sale, how to secure the transaction, and so on. It is costly to use markets. Today these are known as “transaction costs”.
Coase argued that firms existed because they could economise on those transaction costs. Some costs of using the market were suppressed within the firm. And so we had a new understanding of why some economic activity occurs in markets and some economic activity is arranged in firms.
Coase’s insight has given rise to a massive academic literature and has been highly influential (he is recognised as being the founder of New Institutional Economics or Transaction Cost Economics).[5] Yet by 1972 Coase was still suggesting that his paper was more cited than read. A nice problem to have (better than read and not cited, or neither read or cited). The problem was that Coase had identified that costs affect how we organize our economic activity, but he had not operationalised those costs. That task fell to Oliver Williamson.
Oliver Williamson (1932–2020) was an American economist who won the economics Nobel (with Elinor Ostrom) in 2009. Building on Coases’ insight about why firms exist, Williamson examined the ‘make of buy’ decision: should a firm produce goods in-house or buy those goods on the market?
The assumptions of standard mainstream economic analysis were unsuited to answering this question, and so Williamson deviated by introducing bounded rationality and opportunism.[6] Bounded rationality is the recognition that there are limits to human cognition. The computational power of our brains are limited. We are often unable to articulate the precise nature of the transaction we are contemplating. Opportunism is “self-seeking with guile”. In standard economic theory people do not lie, steal or cheat. Reality is much different. Williamson suggests people engage in “the incomplete or distorted disclosure of information, especially to calculated efforts to mislead, distort, disguise, obfuscate, or otherwise confuse”.
As someone in the education sector, opportunism should come as no surprise to you. Students cheat on term papers. Faculty publish in predatory journals or fake research results. Parents may bribe university officials to enrol their students. The number of scandals involving universities seems to be increasing over time. And we all know the faculty who haven’t researched in a decade despite the fact you pay them for it.
Added to opportunism and bounded rationality, Williamson introduced the notion of asset specificity. It is here that his work overlaps with that of another economics laureate Oliver Hart. The London-born Oliver Hart won the Nobel in 2016 and is now at Harvard University.
Asset specificity is the notion that capital is not homogeneous. Once again, for many real-world practical people this is obvious. Many people would be familiar with the notion that a particular machine or process is vital for the production of a particular output but has no other useful purpose. Williamson set out the implications of the existence of such assets for the ‘make or buy decision’, while Hart explains who should own those assets.
The heterogeneity of assets ultimately drives the ‘make or buy decision’. Asset specificity means that the firm should make the goods, while homogeneity means that the firm should buy whatever it needs on the market. That is, specialised inputs or specialised equipment indicate a make decision (not a buy decision). From this perspective, the firm is a “nexus of contracts”. Some contracts are short-term contracts (or market transactions) while others are long-term contracts—what Williamson calls governance relationships.
But long-term contracts are difficult to manage and police. Think of tenure in the university environment. An academic is given life-time employment with little ability to control their future behaviour. It is here that what Williamson calls ‘maladaptation costs’ become important. The notion of ‘maladaptation’ was developed by the Japanese economist Masahiko Aoki.[7] He suggested that the ‘optimal’ contract that people wanted to enter into deviated over time due to changing circumstances. This deviation imposes costs on at least one of the contracting parties. If both parties were adversely affected they would agree to renegotiate. But if only one party were adversely affected the other party could refuse. This gives rise to what economists call the ‘hold-up problem’.
It is because of hold-up that Oliver Hart argues there is more to a firm than contracting—there must be ownership over assets. Hart provides the following example in his Nobel Prize lecture:[8]
Consider a power plant that locates next to a coal mine with the purpose of burning coal to make electricity. One way to regulate the transaction is for the power plant to sign an arms-length long-term contract with the coal mine. Such a contract would specify the quantity, quality, and price of coal for many years to come. But any such contract will be incomplete. Events will occur that the parties could not foresee when they started out.
For example, suppose that the power plant needs the coal to be pure but that it is hard to specify in advance what purity means, given that there are many potential impurities. Imagine that ten years into the relationship, ash content is the relevant impurity and that high-ash-content coal is more expensive for the power plant to burn than low-ash-content coal but cheaper for the coal mine to produce. Given that the contract is incomplete, the coal mine may be within its rights under the contract to supply high-ash-content coal. The power plant and coal mine can, of course, renegotiate the contract. However, the coal mine is in a strong bargaining position. It can demand a high price for switching to low-ash-content coal. The reason is that the power plant does not have a good alternative: it may be very expensive for the power plant to transport coal from a different coal mine given that it is located next to this one.
This is an easy problem to understand. Hart’s solution to the hold-up problem is ownership; the power plant buys the coal mine. In the example, the power plant’s business model is to burn coal, to generate, and then sell, electricity. In order to do so, it must own the coal mine. In principle, it should also own the generators.
Finding your university’s ‘Hart Assets’
While Hart does not perform this particular exercise, three of us have previously argued that it is possible to flip the analysis: what asset(s) does a firm need to own in order to develop a profitable business model?[9] That asset is the firm’s ‘Hart Asset’. A Hart Asset is the asset that the firm cannot trust someone else to own. It is important to recognise that ownership of the Hart asset per se is not the business model. The Hart Asset will be a specific asset (asset specificity in Williamson’s terminology) to the firm but it may not necessarily be the highest earning asset in the firm or be at the point of sale in the business model.
You must own your Hart Asset. No one else can be trusted with it. And so you must identify it and never let it go. Your university probably holds millions or billions of dollars worth of assets in its portfolio: property, buildings, sporting facilities, libraries, equipment, some intellectual property, financial assets, accumulated goodwill (i.e. reputation) and other intangible assets.
Which one is it? Unfortunately we cannot identify it for you (that’s your job, using your deep institutional knowledge). What we can do is set out some broad parameters to help you find it. Many universities will misdiagnose their Hart Asset. They will probably mistakenly ask their faculty to identify it. So let’s begin with what is not a Hart Asset to the university: individual faculty members.
Universities do not own their faculty, or their faculty’s intellectual output. Many universities claim to own the intellectual capital of their employees. Although it may be shocking to many faculty to realise they are employees, that is what they are (albeit with some unusual characteristics).
Although faculty are employees, in practice this is not correct. Imagine a brilliant lawyer, genius, top-of-her-field, with a long client list bringing in millions of revenue, and who is knocking on the door of the top-tier firm’s partnership. Imagine that she suddenly resigns from her current employer and signs on to a competing firm. What would happen? Her current employer would place her on ‘gardening leave’ for the period of her notice period—perhaps lasting a number of months—where she would be effectively barred from working. Her open files would all be assigned to other lawyers in the firm and she would be legally prohibited from approaching her former clients to encourage them to move firms with her.
Now imagine the same person, but as a brilliant professor of law and economics, with a stream of ground breaking publications, millions in research funding, dozens of PhD students, and is touted as a potential Nobel prize winner. Imagine now that she resigns from her current employer and moves to a competitor university (not that universities view other universities as competitors, of course). What would happen? Well, something very different. She would simply update her forthcoming papers with her new affiliation, move offices, take her funding and many of her PhD students too, and simply carry on her work under a new letterhead (or perhaps, email address). The kudos of being her employer would seamlessly transfer from one employer to the other as she transferred all her human and intellectual capital to her new employer.
To reiterate, neither the faculty nor their intellectual capital are Hart Assets to the university.
If we think of faculty within the make or buy framework, faculty are ‘bought’, they are not made. If a university wishes to have an academic with particular skills they do not begin training up an undergraduate. Rather universities go to the (labour) market to acquire (employ) such an academic. To be sure, universities train academics. But many universities are reluctant to employ their own graduates. And in many circles, the practice of employing too many of your own graduates is viewed as being disreputable.
The implication of this is that universities are not subject to the ‘hold-up problem’ that Hart describes when employing faculty. This insight will come as an unwelcome surprise to many faculty (and your authors may no longer be welcome in the staff room for making this point). But it turns out that academics and faculty are not the most important asset a university has, despite university Presidents and Vice-Chancellors often claiming “our staff are our most valuable asset”.
Returning to our initial list of possible assets included “property, buildings, sporting facilities, libraries”. These are not Hart Assets either. Whether it is a particle accelerator or a football stadium, despite being very specific and specialised, the university will not need to own these assets. These assets can be governed through contractual arrangements. Instead, the physical aspects of the university that we can touch and see is the infrastructure that delivers the intangible assets that universities actually provide.
Hart Assets are intangible assets
In our list of assets that we said universities own, we were a bit vague in listing “other intangible assets” without being specific. What are those intangible assets? Clearly reputation is an intangible asset. But reputation isn’t the only intangible asset that universities own.
Jonathan Haskel and Stian Westlake provide four characteristics of intangible assets:
Intangible assets represent a sunk cost;
Intangible assets generate spillovers;
Intangible assets are more likely to be scaleable; and
Intangible assets have synergies with other assets.[10]
The University of Maryland emeritus professor of economics Charles Hulten has argued that intangible assets, “typically involve the development of specific products or processes, or are investments in organizational capabilities, creating or strengthening product platforms that position a firm to compete in certain markets”.[11]
Universities are repositories of massive amounts of intangible capital. Two examples provide an illustration. First, recall our earlier argument that university education is a credence good (see Part 2). What can a university say about a graduate? Graduate X was exposed to information Y, and assessed in process Z. How was graduate X originally selected? How were they exposed to information Y? What information is Y? What were the assessment processes Z? How was progress recorded?
All these questions suggest that there is some process in place that underpins what universities do, how they do it, and why they do it. What universities do is they match students, faculty, and facilities in a process that results (hopefully, and more often than not) in graduates that can claim to have mastered a particular body of knowledge and they communicate that information to the world in a credible way.
Second, every week of term, every one of the many thousands of students on every university campus is matched with a classroom and a teacher for lectures, tutorials, and laboratory classes. Thousands of students are selected, as are the teachers—who can only be in one place at a time. Nobody in the selection process is obviously a fool and the facilities are, more or less, fit for purpose. But this is a non-trivial task.
No university ever advertises how good their back-room operations are, or how comprehensive their policies and procedures are, yet for all universities this is a Hart Asset. This is the most important thing the university does. It is a logistics task done by the back room operation. For all universities, the administration is the most valuable Hart Asset.
Every university must have a Hart Asset—an intangible asset that the university cannot trust another entity to own. That is not to say that all Hart Assets are equally valuable. Some Hart Assets are more valuable than others and not all universities will have the same asset being their Hart Asset (or, at least, not their most valuable Hart Asset). Further, some Hart Assets are scaleable. Others are not. What your Hart Asset(s) are determines what type of university you are (and what choices you should make in that direction).
In the next part we explore more deeply three different university types. But here’s a teaser. Harvard University has two Hart Assets: policies and procedures that are, no doubt, excellent; and a reputation as being one of the best universities in the world. For Harvard it’s reputation is its most valuable Hart asset because Harvard is an elite and exclusive school. Scaling its reputation might not even be possible. Harvard epitomises elite universities.
Now consider the University of the Arts London. While Harvard provides elite education across multiple areas and disciplines this university is small and highly specialised in the performing arts, art, design, and fashion. Their Hart Asset is their reputation in those narrowly defined areas. These are the specialist universities.
Then you have those universities that have their policies and procedures that can be scaled up. Their Hart Assets are their back office operations, their administration. Those universities can massively expand their operations. These are the platform universities.
Part 5 takeaways
Strategy must always come back to your university’s strategic assets. And to understand those assets you need some tools from economics.
For over half a century, economists have been exploring seemingly basic questions. Why do firms exist? Why do firms buy some products over a market, but produce other products in-house?
Following the work of Ronald Coase and Oliver Williamson (among others), economist Oliver Hart demonstrated the importance of ownership of highly specific assets (rather than firms imply being a nexus of contracts).
We introduce the concept of a Hart Assets as the strategic assets that you cannot afford your competitors to own or control. You need to identify them in order to develop a profitable business model.
Perhaps your Hart Assets are teaching or specialist research, or elite reputation. Or maybe they’re much more mundane administrative capabilities. Which one is it?
References
[2] Smith, A. 1776 [1976]. The Wealth of Nations, p. 284.
[3] See Braga, M, Paccagnell, M, and Pellizzari, M. 2014. Evaluating students’ evaluations of professors. Economics of Education Review 41: 71-88.
[4] Coase, R. 1937. ‘The Nature of the Firm’, Economica, vol. 4(16):, p. 386-405.
[5] Strictly these transaction costs should be broken up into transaction costs per se and information costs. Economists also have recently become aware of how important the notion of trust is in securing transactions.
[6] Williamson, O. 1975. Markets and Hierarchies: Analysis and Antitrust Implications. The Free Press; Williamson, O. 1985. The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting. The Free Press.
[7] Aoki, M. 1983. Managerialism revisited in the light of bargaining-game theory, International Journal of Industrial Organization, 1(1), p. 1-21.
[8] Oliver H. 2016. Incomplete Contracts and Control, Nobel Prize Lecture, available at https://www.nobelprize.org/uploads/2018/06/hart-lecture.pdf
[9] Davidson, S., Berg, C., & Potts, J. 2020. The Hart asset at the heart of your organisation. Available at SSRN 3738418.
[10] Haskel, J and Westlake, S. 2018. Capitalism Without Capital: The Rise of the Intangible Economy, Princeton University Press.
[11] Hulton, CR. 2010. Decoding Microsoft: Intangible Capital as a Source of Company Growth, NBER Working Paper No. 15799 <https://www.nber.org/papers/w15799>.