Make Your Best Offers: The Power of Price Sensitivity
The second in The Maguire Network pricing and value article series
Student enrollment choices are influenced by complex issues. For many students, availability of majors, career outcomes, location, college or university mission, athletics, and perceived institutional prestige play major roles. During the recruitment process, institutions deliver information on each of these items and much more. At the time of the admission offer, however, one factor rises in importance: net cost.
Institutions would like to meet families' full financial need with grants, but few can afford such a policy. Finding the right price point and discount rate, while difficult, is essential to long-term financial sustainability. Discounting tuition too little will fail to enroll enough students to fill capacity. Discounting too much will over-award students who would be likely to enroll with smaller financial aid packages. Both are detrimental to net revenue. To enroll the best class possible with available resources, most institutions need to deploy institutional financial aid strategically and systematically. The first step for your institution is making an accurate assessment of your students’ price sensitivity.
What is price sensitivity?
“Price sensitivity” is a term used in various industries. In higher education, price sensitivity is a measure of the impact of the published sticker price on students’ application decisions and of financial aid awards on students’ enrollment decisions. Price sensitivity varies greatly across the spectrum of institutional types and within a given college or university's admitted student pool. It can differ by such metrics as student ability (as indicated by test scores, subjective ratings, or high school GPA) or financial need, for example.
Put simply, price sensitivity reflects how reactive students are to the full list price and eventual net cost (list price defined as the institution’s published tuition and fees, and net cost as the amount that an individual family is actually asked to pay after both institutional and governmental financial aid awards are taken into account). In this article, we are focusing on the net cost component of price sensitivity, a key driver of student enrollment decisions. It is important to know how your markets respond to net costs because, once trustees vote in the next price increase, you need to be able to minimize the financial risk and maximize the potential of your awarding strategy.
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Quantifying the Price Sensitivity Ratio
The price sensitivity ratio identifies the boundaries of your admitted students’ price sensitivity. It is calculated by determining the relationship between the number of students who would enroll if every admitted student received a full scholarship and the number of students who would enroll if no one received any institutional grant aid. That ratio, whether high, moderate, or low, has important implications for student recruitment and the development of fiscally sound financial aid awarding strategies.
Since each family’s optimal price point is different and each institution serves students and families with a unique combination of characteristics, what’s the best way for an institution to look at price sensitivity in its admitted student pool? We suggest two operating principles:
- Focus on your own institutional awards. Since government financial aid programs for individual students typically are consistently applied across institutions, price sensitivity can be determined by modeling just your own grants offered to admitted students.
- Understand the entire admitted pool first. It is most cost-efficient to award admitted students individually and it is possible to use econometric modeling to calculate awards at the individual student level. However, determining the price sensitivity of the admitted student pool is best begun by analyzing student behavior in the aggregate. This allows for direct benchmarking and comparisons, both over time and with other institutions. Once you have a perspective on your entire admitted student population, only then does it make sense to begin developing an individualized awarding strategy.
Interpreting the Price Sensitivity Ratio Results
A low price sensitivity ratio – say, 4:1 – means that money isn't currently affecting student behavior very much. This is typically due to either high prestige (students are willing to pay more or assume greater debt to enroll at institutions with the highest perceived quality and value) or low award variability (many students have been offered the same or very similar awards in the past, making it statistically impossible to gauge the comparative affects of the award amounts).
A high price sensitivity ratio – greater than 20:1 – means that the impact of each dollar spent in institutional aid is more immediate, which has some advantages. However, it is most often expensive to provide sufficient incentive for students to enroll because cost is such a dominant factor in their enrollment decision.
While extreme cases like these exist, the majority of institutions have price sensitivity ratios in a more moderate range, between 8:1 and 16:1. Using the story of Goldilocks and the Three Bears as inspiration, it would seem that a price sensitivity ratio can be too high, too low, or just right. Institutions with students in that “just right” range have the greatest opportunity to make strides in meeting institutional goals with strategic financial aid awarding. Their students tend to respond to less expensive financial incentives and therefore bring in more net revenue. For those with challenges at the extremes, longer term advancements can be made through careful multi-year iterations and affordable investments, guided by ongoing observation of their students’ reactions to net costs.
Putting the Price Sensitivity Ratio to Use
Wherever your institution's admitted student population falls on the price sensitivity spectrum, here are some guidelines to help your institution explore the big picture and put that information into practice:
- Determine the measurable drivers of enrollment – those variables that have a statistically significant relationship with students’ choices to enroll or not to enroll at your institution. These variables are the basis for an equation from which you can model student price sensitivity.
- Pay attention to low-yielding students. It's a mistake to focus only on students who are most likely to enroll. In order to advance into new markets and expand the breadth of your student body, you need also to focus on those students who have been least likely to enroll in the past.
- Create financial aid awarding scenarios to explore the effect of differing net costs on the profile, size, and revenue of a first year class. The scenarios should include finding the boundaries that define the price sensitivity ratio of your most recent admitted class.
- Continually evaluate your admitted students' price sensitivity ratio over time. It's important to remember that your price sensitivity ratio is not for your institution, but your institution's admitted students and their willingness to pay to enroll at your college or university. As your admitted pool, your awarding strategies, and your institution evolve, you need to continue to monitor current admitted student price sensitivities.
- Demonstrate and reinforce your institution's values in your awarding policies. Despite the competitive environment in which you make key financial aid awarding decisions, it's incumbent upon leaders to utilize awards to advance the mission and overarching priorities of your instituiton. Always consider potential unintended consequences when crafting an awarding strategy.
The power of price sensitivity is its ability to heighten your awareness of what is achievable and affordable for your institution. With spiraling tuition and fees at both public and private institutions, more students than ever are basing a significant portion of their college choice on cost and value. And as costs become increasingly daunting for families and government support continues to erode, colleges and universities can no longer risk committing to a financial path without a clear understanding of the role of student price sensitivity.