Harvard Business School risks going from great to good

Date: 04-05-2017
Source: The Economist: Schumpeter

A confidential memorandum of warning to its senior faculty

YOU will all be aware that a book has just been published about our institution, Harvard Business School (HBS). Entitled “The Golden Passport”, by Duff McDonald, it makes a number of unflattering claims about the school’s ethics and its purpose. While often unbalanced, it is likely to galvanise hostility to HBS both inside Harvard University, of which we are a part, and among the public. This memorandum, circulated only to the most senior faculty members, assesses HBS’s strategic position.

Our school has been among the country’s most influential institutions since its foundation in 1908. Our forebears helped build America’s economy in the early 20th century and helped win the second world war. HBS educates less than 1% of American MBA students but case studies written by our faculty are used at business schools around the world. Our alumni fill the corridors of elite firms such as McKinsey. Many bosses of big American companies studied here. Even in Silicon Valley, where we are relatively weak, about a tenth of “unicorns”—private startups worth over $1bn—have one of our tribe as a founder.
We have a business model that monetises the Harvard brand through four revenue streams. About $127m, or 17%, of sales come from MBA tuition fees. Our case-study method, in which students learn from real business situations, is popular. But it is only one reason why they are willing to pay headline fees of $71,635 a year. Like parents of pupils at Britain’s elite private schools, they are buying social standing as well as access to an alumni network that will dramatically raise their odds of getting high-paying jobs.

A further 23% of sales comes from our executive-education operation, which sells short courses to mid-career executives. They get a modest amount of mental stimulation and the right to call themselves Harvard alumni. We get $176m a year in return. Our publishing arm sells case studies to other universities and publishes books and a magazine; that brings in 29% of our revenues. The remaining 31% comes chiefly from wealthy businessmen in the form of donations. Some of them may well be under the impression that they gain influence over what we teach.

We have had a fantastic run of it, with sales growing at a compound annual rate of 8% in the past decade, above the university’s rate of 5% and outperforming the median firm in the S&P 500 index. Our balance-sheet is strong, with $3.2bn of endowment funds (run by the university’s management company) and $1.6bn of other assets, including our campus. You have all benefited handsomely; we pay out a higher share of our income in compensation than Goldman Sachs does. It may look like poor cost control, with expenses rising at a 7% annual rate, but it also means we live up to our legal status as a non-profit organisation. After deducting capital expenditure, the school makes a modest loss.

However, we face three strategic problems. First, conflicts of interest—let’s be honest here—that have become glaring. We grant companies a veto over case studies written about them. We permit our faculty to be paid, for example, through consulting gigs, by firms they teach about. We do case studies on some of our big donors. It is likely that this compromises our objectivity.

Second, we face ever more competition to our claim to intellectual leadership. Important business thinkers such as Michael Porter and Clayton Christensen are still on staff, but a new generation of superstars has not yet caught fire. The authors of the most influential recent business book, “The Second Machine Age”, work across the Charles river at the Massachusetts Institute of Technology. As the tech industry expands, its chief alma mater, Stanford University, is growing ever more powerful.

Last, we may perpetuate inequality, a relevant subject at the moment. We have worked to make our intake of students more diverse. But even after the financial aid that we give to some, we have ramped up our effective MBA fees by 31% over the past five years. Relative to the median salary our graduates earn in their first year at work, our fees are twice as costly as they were in 1986. It doesn’t take much to see our network as a form of cronyism.

Left unaddressed these weaknesses could compromise our business model. If HBS is more about cash and contacts than ideas, bright people may eventually go elsewhere. Other schools may stop buying our case studies if they doubt their objectivity. We are part of Harvard University, but our already uneasy relationship with it could deteriorate. We benefit from an implicit subsidy because we can use the Harvard brand while operating at arm’s length. In return they benefit from our alumni, who often donate to the university as well as to HBS. But the university has, at least notionally, the power to overhaul our management.

The Boston Business School Inc
Our school, led by Nitin Nohria, dean since 2010, has made important reforms. We have tightened disclosure rules on conflicts of interest. Students must spend time in emerging markets. We have tried to signal that our interests go beyond shareholder value by publishing essays criticising it. Yet deeper changes are needed if we are to maintain our competitive position. One course is to reduce the influence of big money and fully eliminate conflicts. Our dependence on big donors’ generosity would have to fall and, by implication, we would have to be less extravagant.

If you have a good thing going, though, why stop? An alternative is to follow the advice of Alfred Chandler, a theorist at HBS between 1970-89, who taught that structure must reflect strategy. HBS would cut loose from Harvard and acknowledge its tacit commercial status. If we trimmed costs to their level five years ago and were valued on the S&P 500’s price-earnings multiple, HBS would be worth $5bn. The university would get a huge special dividend with which to pay for more scholarships for underprivileged applicants. We would be subject to the forces of accountability and transparency that we have always argued maximise performance. We look forward to your feedback.

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